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A note resolving the debate on “The weighted average cost of capital is not quite right”

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  • Keef, Stephen P
  • Khaled, Mohammed S
  • Roush, Melvin L

Abstract

Miller (2009a) derives a weighted average cost of capital for the special case where the cash flows to equity and the cashflows to debt are annuities. The paper attracts debate. We show that the weighted average cost of capital is redundant in a world where interest paid is not tax deductible. The required rate of return on unlevered equity will consistently and reliably estimate the net present value of any project no matter the idiocyncratic beliefs of the analyst as to the year-by-year leverage of the project, or of the firm. We recommend that the weighted average cost of capital method is discarded. Our recommendation also applies to a world where interest paid is tax deductible.

Suggested Citation

  • 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.
    • Handle: RePEc:vuw:vuwecf:18609
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    File URL: https://ir.wgtn.ac.nz/handle/123456789/18609
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    References listed on IDEAS

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    1. Myers, Stewart C, 1974. "Interactions of Corporate Financing and Investment Decisions-Implications for Capital Budgeting," Journal of Finance, American Finance Association, vol. 29(1), pages 1-25, March.
    2. 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.
    3. 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.
    4. 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.
    5. Pierru, Axel, 2009. ""The weighted average cost of capital is not quite right": A rejoinder," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(4), pages 1481-1484, November.
    6. Miles, James A. & Ezzell, John R., 1980. "The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(3), pages 719-730, September.
    7. Miller, Richard A., 2009. "The weighted average cost of capital is not quite right: Reply to M. Pierru," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(3), pages 1213-1218, August.
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