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Weighted Average Cost of Capital

The policies of the Federal Reserve Bank (Fed) will have an impact on the weighted average cost of capital (WACC). Most importantly, it should be noted that long-term interest rates are connected by the decisions of the Fed (Brigham, & Ehrhardt, 2017). This impacts the value of long-terr because the is a dependency between the two since if the interest rate is increasing, the value of stocks decreases and vise versa. This is accomplished in two main ways – by changing the supply of money in the monetary system and by altering the actual interest rate of the Fed itself. Hence, the Fed is one of the major institutions that impact the WACC.

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WACC consists of all types of stock and dept that a business has. This includes common stock, preferred, as well as bonds and other long-term debt obligations (Hargrave, 2019). The WACC value considers each of these factors and multiplies them by their relative weight to estimate the company’s WACC. The cost of capital is calculated as part of WACC is affected by the risk-free rate, influenced by the Fed’s money supply operations.

When estimating WACC, mistakes such as calculating the cost of equity often arise. This issue is connected to the need to choose an appropriate model, either the Gordon Growth Model or Capital Asset Pricing Model (CAPM). The two use different assumptions for evaluation and consider various qualitative and quantitative factors. Thus, one must approach the calculations with caution and determine which model is the most suitable for the business. Other mistakes include errors when evaluating the risk-free rate or market risk premium. These issues can be mitigated by examining all factors and opportunities that can arise in the future to account for all possibilities that can affect the businesses WACC.

References

Brigham, E. F., & Ehrhardt, M. C. (2017). Financial management: Theory and practice [with MindTap] (15th ed.). Mason, OH: South-Western.

Hargrave, M. (2019). Weighted average cost of capital – WACC. Web.

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StudyCorgi. (2021, July 30). Weighted Average Cost of Capital. Retrieved from https://studycorgi.com/weighted-average-cost-of-capital/

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StudyCorgi. "Weighted Average Cost of Capital." July 30, 2021. https://studycorgi.com/weighted-average-cost-of-capital/.

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StudyCorgi. 2021. "Weighted Average Cost of Capital." July 30, 2021. https://studycorgi.com/weighted-average-cost-of-capital/.

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StudyCorgi. (2021) 'Weighted Average Cost of Capital'. 30 July.

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