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Does the Weighted Average Cost of Capital Describe the Real-World Approach to the Discount Rate?

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  • Stanley Block

Abstract

Almost every capital budgeting textbook has a chapter on the weighted average cost of capital (WACC). Though this is theoretically satisfying, it does not describe how companies actually operate. The WACC calls for a balanced capital structure in which debt and equity are utilized at some predetermined percentage. The problem is that researchers have shown that firms try to avoid selling new shares whenever possible. This leads to the pecking order theory in which firms first use internal funds, then low-risk debt, then high-risk debt, and finally, as a last resort, new common stock. There is no attempt to balance the capital structure. This survey study basically confirms that approach.

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  • Stanley Block, 2011. "Does the Weighted Average Cost of Capital Describe the Real-World Approach to the Discount Rate?," The Engineering Economist, Taylor & Francis Journals, vol. 56(2), pages 170-180.
    • Handle: RePEc:taf:uteexx:v:56:y:2011:i:2:p:170-180
    DOI: 10.1080/0013791X.2011.573618
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    Cited by:

    1. Biase di Giuseppe & Guglielmo D'Amico & Jacques Janssen & Raimondo Manca, 2014. "A Duration Dependent Rating Migration Model: Real Data Application and Cost of Capital Estimation," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 64(3), pages 233-245, June.
    2. Saleh F.A. Khatib & Dewi Fariha Abdullah & Ali Shariff Kabara & Saddam A. Hazaea & Tamil Selvi Rajoo, 2020. "Does Debts have any Impact on Governance Bundle and Agency Costs? Over-Governance Hypothesis," Technium Social Sciences Journal, Technium Science, vol. 9(1), pages 384-396, July.
    3. Paula de Souza & Rogério João Lunkes, 2016. "Capital budgeting practices by large Brazilian companies," Contaduría y Administración, Accounting and Management, vol. 61(3), pages 514-534, Julio-Sep.
    4. Magni, Carlo Alberto & Marchioni, Andrea, 2020. "Average rates of return, working capital, and NPV-consistency in project appraisal: A sensitivity analysis approach," International Journal of Production Economics, Elsevier, vol. 229(C).
    5. Magni, Carlo Alberto & Marchioni, Andrea & Baschieri, Davide, 2022. "Impact of financing and payout policy on the economic profitability of solar photovoltaic plants," International Journal of Production Economics, Elsevier, vol. 244(C).
    6. Juhász, Péter, 2019. "A súlyozott átlagos tőkeköltség alkalmazásának kihívásai [Challenges in applying the weighted average cost of capital]," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(7), pages 805-823.

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