IDEAS home Printed from https://ideas.repec.org/a/eee/quaeco/v49y2009i1p128-138.html
   My bibliography  Save this article

The weighted average cost of capital is not quite right

Author

Listed:
  • Miller, Richard A.

Abstract

A firm's cost of capital used in discounted cash flow analysis is commonly calculated as a weighted average of the after tax costs of the firm's various sources of financing (equity, debt, preferred stock). Its use implies that for investment projects earning precisely the WACC the cash (in)flow is exactly sufficient to reward all the suppliers of finance with their respective costs of capital. However, the necessary cash flow (normal profit) implied by the WACC is inadequate to provide the cash flows to the individual sources of financing when they are considered separately. This note discusses the problem (WACC is a linear approximation of a nonlinear relationship) and presents a modification of the WACC which is conceptually superior to the WACC as commonly calculated.

Suggested Citation

  • Miller, Richard A., 2009. "The weighted average cost of capital is not quite right," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(1), pages 128-138, February.
    • Handle: RePEc:eee:quaeco:v:49:y:2009:i:1:p:128-138
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1062-9769(06)00121-9
    Download Restriction: Full text for ScienceDirect subscribers only
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Jianjun Miao, 2005. "Optimal Capital Structure and Industry Dynamics," Journal of Finance, American Finance Association, vol. 60(6), pages 2621-2659, December.
    2. Mark T. Leary & Michael R. Roberts, 2005. "Do Firms Rebalance Their Capital Structures?," Journal of Finance, American Finance Association, vol. 60(6), pages 2575-2619, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Tor Brunzell & Eva Liljeblom & Mika Vaihekoski, 2013. "Determinants of capital budgeting methods and hurdle rates in Nordic firms," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(1), pages 85-110, March.
    2. Demetri Tsanacas, 2022. "Valuation Challenges in High Tech Platform Based Corporations," International Journal of Economics & Business Administration (IJEBA), International Journal of Economics & Business Administration (IJEBA), vol. 0(1), pages 89-100.
    3. Keef, Stephen P & Khaled, Mohammed S & Roush, Melvin L, 2011. "Miller's (2009) WACC model: An extension," Working Paper Series 1995, Victoria University of Wellington, School of Economics and Finance.
    4. Keef, Stephen P & Khaled, Mohammed S & Roush, Melvin L, 2011. "A note resolving the debate on “The weighted average cost of capital is not quite rightâ€," Working Paper Series 2003, Victoria University of Wellington, School of Economics and Finance.
    5. Bade, Benjamin, 2009. "Comment on "The weighted average cost of capital is not quite right"," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(4), pages 1476-1480, November.
    6. Zbysław Dobrowolski & Grzegorz Drozdowski & Mirela Panait & Simona Andreea Apostu, 2022. "The Weighted Average Cost of Capital and Its Universality in Crisis Times: Evidence from the Energy Sector," Energies, MDPI, vol. 15(18), pages 1-15, September.
    7. Fabrizio Cacciafesta, 2015. "Using the WACC to rate a new project," CEIS Research Paper 339, Tor Vergata University, CEIS, revised 10 Apr 2015.
    8. Aulová, R. & Frydlova, M., 2012. "EVA and its Determinants for Selected Groups of Farms: Conventional and Organic Farming," AGRIS on-line Papers in Economics and Informatics, Czech University of Life Sciences Prague, Faculty of Economics and Management, vol. 4(3), pages 1-11, September.
    9. Justyna Franc-Dąbrowska & Magdalena Mądra-Sawicka & Anna Milewska, 2021. "Energy Sector Risk and Cost of Capital Assessment—Companies and Investors Perspective," Energies, MDPI, vol. 14(6), pages 1-20, March.
    10. Sumiyana Sumiyana & Ainun Na’im & Firdaus Kurniawan & Albertus H. L. Nugroho, 2023. "Earnings management and financial distress or soundness determining CEOs’ future over- and under-investment decisions," Palgrave Communications, Palgrave Macmillan, vol. 10(1), pages 1-10, December.
    11. Pierru, Axel, 2009. ""The weighted average cost of capital is not quite right": A comment," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(3), pages 1219-1223, August.
    12. Keef, Stephen P & Khaled, Mohammed S & Roush, Melvin L, 2011. "Miller's (2009) WACC model: An extension," Working Paper Series 18608, Victoria University of Wellington, School of Economics and Finance.
    13. Keef, Stephen P. & Khaled, Mohammed S. & Roush, Melvin L., 2012. "A note resolving the debate on “The weighted average cost of capital is not quite right”," The Quarterly Review of Economics and Finance, Elsevier, vol. 52(4), pages 438-442.
    14. Keef, Stephen P & Khaled, Mohammed S & Roush, Melvin L, 2011. "A note resolving the debate on “The weighted average cost of capital is not quite right”," Working Paper Series 18609, Victoria University of Wellington, School of Economics and Finance.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Katagiri, Mitsuru, 2014. "A macroeconomic approach to corporate capital structure," Journal of Monetary Economics, Elsevier, vol. 66(C), pages 79-94.
    2. Francis, Bill B. & Hasan, Iftekhar & Kostova, Gergana L., 2016. "When do peers matter? A cross-country perspective," Bank of Finland Research Discussion Papers 8/2016, Bank of Finland.
    3. Li, Larry & Islam, Silvia Z., 2019. "Firm and industry specific determinants of capital structure: Evidence from the Australian market," International Review of Economics & Finance, Elsevier, vol. 59(C), pages 425-437.
    4. Gryglewicz, Sebastian, 2011. "A theory of corporate financial decisions with liquidity and solvency concerns," Journal of Financial Economics, Elsevier, vol. 99(2), pages 365-384, February.
    5. Antill, Samuel & Grenadier, Steven R., 2019. "Optimal capital structure and bankruptcy choice: Dynamic bargaining versus liquidation," Journal of Financial Economics, Elsevier, vol. 133(1), pages 198-224.
    6. repec:zbw:bofrdp:2016_008 is not listed on IDEAS
    7. Chen, Chang-Chih & Huang, Henry Hongren & Lee, Chun I., 2022. "Supply chain, product pricing, and dynamic capital structure," International Review of Economics & Finance, Elsevier, vol. 80(C), pages 938-952.
    8. Ebrahim, M. Shahid & Girma, Sourafel & Shah, M. Eskandar & Williams, Jonathan, 2014. "Dynamic capital structure and political patronage: The case of Malaysia," International Review of Financial Analysis, Elsevier, vol. 31(C), pages 117-128.
    9. Natalia Szomko, 2020. "Factors Associated with the Capital Structure of Polish Companies in the Long and Short Term," Gospodarka Narodowa. The Polish Journal of Economics, Warsaw School of Economics, issue 1, pages 55-74.
    10. Francis, Bill B. & Hasan, Iftekhar & Kostova, Gergana L., 2016. "When do peers matter?: A cross-country perspective," Journal of International Money and Finance, Elsevier, vol. 69(C), pages 364-389.
    11. Belkhir, Mohamed & Maghyereh, Aktham & Awartani, Basel, 2016. "Institutions and corporate capital structure in the MENA region," Emerging Markets Review, Elsevier, vol. 26(C), pages 99-129.
    12. Ogden, Joseph P. & Wu, Shanhong, 2013. "Reassessing the effect of growth options on leverage," Journal of Corporate Finance, Elsevier, vol. 23(C), pages 182-195.
    13. Kim Huynh & Robert Petrunia & Joel Rodrigue & Walter Steingress, 2023. "Exporting and Investment Under Credit Constraints," Staff Working Papers 23-10, Bank of Canada.
    14. Ban, Mingyuan & Chen, Chang-Chih, 2019. "Ambiguity and capital structure adjustments," International Review of Economics & Finance, Elsevier, vol. 64(C), pages 242-270.
    15. Marco Botta & Luca Colombo, 2016. "Macroeconomic and Institutional Determinants of Capital Structure Decisions," DISCE - Working Papers del Dipartimento di Economia e Finanza def038, Università Cattolica del Sacro Cuore, Dipartimenti e Istituti di Scienze Economiche (DISCE).
    16. Nguyen, Thao & Bai, Min & Hou, Greg & Vu, Manh-Chien, 2020. "State ownership and adjustment speed toward target leverage: Evidence from a transitional economy," Research in International Business and Finance, Elsevier, vol. 53(C).
    17. Agnieszka Kuś & Dorota Grego-Planer, 2021. "A Model of Innovation Activity in Small Enterprises in the Context of Selected Financial Factors: The Example of the Renewable Energy Sector," Energies, MDPI, vol. 14(10), pages 1-17, May.
    18. Andres, Christian & Cumming, Douglas & Karabiber, Timur & Schweizer, Denis, 2014. "Do markets anticipate capital structure decisions? — Feedback effects in equity liquidity," Journal of Corporate Finance, Elsevier, vol. 27(C), pages 133-156.
    19. Qian Wang & Duowen Wu & Lina Yan, 2021. "Effect of positive tone in MD&A disclosure on capital structure adjustment speed: evidence from China," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 61(4), pages 5809-5845, December.
    20. Kim Huynh & David Jacho-Chávez & Robert Petrunia & Marcel Voia, 2015. "A nonparametric analysis of firm size, leverage and labour productivity distribution dynamics," Empirical Economics, Springer, vol. 48(1), pages 337-360, February.
    21. Wenlian Gao & Feifei Zhu & Kai Chen, 2023. "The role of bank lenders in firm leverage adjustments," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 46(1), pages 63-97, February.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:quaeco:v:49:y:2009:i:1:p:128-138. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/620167 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.