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WACC: Definition, misconceptions and errors

Author

Listed:
  • Fernandez, Pablo

    (IESE Business School)

Abstract

The WACC is just the rate at which the Free Cash Flows must be discounted to obtain the same result as in the valuation using Equity Cash Flows discounted at the required return to equity (Ke) The WACC is neither a cost nor a required return: it is a weighted average of a cost and a required return. To refer to the WACC as the "cost of capital" may be misleading because it is not a cost. The paper includes 7 errors due to not remembering the definition of WACC and shows the relationship between the WACC and the value of the tax shields (VTS).

Suggested Citation

  • Fernandez, Pablo, 2011. "WACC: Definition, misconceptions and errors," IESE Research Papers D/914, IESE Business School.
    • Handle: RePEc:ebg:iesewp:d-0914
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    File URL: http://www.iese.edu/research/pdfs/DI-0914-E.pdf
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    Cited by:

    1. Fabrizio Cacciafesta, 2015. "Using the WACC to rate a new project," CEIS Research Paper 339, Tor Vergata University, CEIS, revised 10 Apr 2015.

    More about this item

    Keywords

    required return to equity; value of tax shields; company valuation; cost of debt;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M21 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics - - - Business Economics

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