Week 6 Forum 1

Week 6 Forum 1
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Week 6 Forum 1
Weighted average cost of capital (WACC) refers to that average rate of return that a firm is supposed to compensate all its different stakeholders (Myers, 2001). Typically, a firm is run by different sources of finances, which can either be borrowed or owned. Therefore, for the company to be able to manage these two types of finances, it is important to have knowledge of its WACC. This will help it to measure the cost of supporting all prospect projects.
It is worth noting that if WACC of a company is low, then the cost of financing fresh project also becomes low. When an organization intends to reduce its WACC then a decision might be made to increase the use of all cheap sources of funds.
The following are the role that WACC plays in determining a project’s cost of capital:
WACC can be used to determine the value of an investment and the type of investment to be selected. WACC can also be used in determining money flow prospect through the application of discount rate. A company may also use WACC as hurdle charge for accessing the possible return of Capital invested by evaluating whether the amount is being used effectively. It is also used in the calculation of the economic value added (EVA)
Therefore, when a company has an accurate WACC then it means that the company has the capacity to accurately evaluate its projects. While if a project shows different risk level than the normal operations, then the company WACC should be adjusted to be in line with the project’s risk.

In conclusion, the WACC is a bit challenging for the investors to use in calculating the cost of capital, but it is important for the investors to have knowledge of it so that they have an idea when it is used in financial reports.
Reference
Myers, S. C. (2001). Capital structure. The journal of economic perspectives, 15(2), 81-102.