Table of Contents
- 1 Do you use target or acquirer WACC?
- 2 Why do we use WACC in DCF?
- 3 What WACC to use in a valuation?
- 4 How do you calculate WACC after acquisition?
- 5 When should you use WACC?
- 6 What are the disadvantages of using WACC?
- 7 Is a high WACC good or bad?
- 8 Why is WACC preferred to book value WACC?
- 9 Why is WACC analysis important for investors?
- 10 What happens if the return is less than the WACC?
Do you use target or acquirer WACC?
Note that in acquisition analysis, the proper WACC is that of the target – not the acquirer. The objective is to discount at a rate that appropriately reflects the risk profile of the investment not the investor; hence the need to use the target’s WACC.
Why do we use WACC in DCF?
If the DCF is above the current cost of the investment, the opportunity could result in positive returns. Companies typically use the weighted average cost of capital (WACC) for the discount rate, because it takes into consideration the rate of return expected by shareholders.
What is WACC in DCF?
WACC , or Weighted Average Cost of Capital, is a financial metric used to measure the cost of capital to a firm. WACC is used to determine the discount rate used in a DCF valuation model. The two main sources a company has to raise money are equity and debt.
What WACC to use in a valuation?
Size and country risk premiums
| Country Risk Premiums | |
|---|---|
| China | 1.1\% |
| India | 3.4\% |
| Middle East | 1.4\% |
| Eastern Europe | 3.1\% |
How do you calculate WACC after acquisition?
If net working capital is decreased, however, it enters as a positive component of free cash flow. A standard estimator of the terminal value in period t is the constant growth valuation formula. , where: FCF is the expected free cash flow to all providers of capital in period t.
Why DCF is not used for banks?
The guide says it’s because fin institutions are highly levered and they do not re-invest debt in the business and instead use it to create products.
When should you use WACC?
Companies use the WACC as a minimum rate for consideration when analyzing projects since it is the base rate of return needed for the firm. Analysts use the WACC for discounting future cash flows to arrive at a net present value when calculating a company’s valuation.
What are the disadvantages of using WACC?
Disadvantages of WACC
- Lack of public information: It hard to calculate WACC for private companies as the information is not publicly available.
- Change in Capital Structure: WACC assumes that the company’s capital structure remains the same over time.
- The company can play around with WACC by increasing the debt.
What are the advantages and disadvantages of WACC?
Moreover, the advantages of using such a WACC are its simplicity, easiness, and enabling prompt decision making. The disadvantages are its limited scope of application and its rigid assumptions coming in the way of evaluation of new projects.
Is a high WACC good or bad?
If a company has a higher WACC, it suggests the company is paying more to service their debt or the capital they are raising. As a result, the company’s valuation may decrease and the overall return to investors may be lower.
Why is WACC preferred to book value WACC?
The book value weights are readily available from balance sheet for all types of firms and are very simple to calculate. Still Market Value WACC is considered appropriate by analysts because an investor would demand market required rate of return on the market value of the capital and not the book value of the capital.
What is target capital structure and WACC?
Target Capital Structure and WACC. A company’s target capital structure refers to capital which the company is striving to obtain. In other words, target capital structure describes the mix of debt, preferred stock and common equity which is expected to optimize a company’s stock price.
Why is WACC analysis important for investors?
It is equally important for investors making valuations of companies. WACC analysis can be looked at from two angles—the investor and the company. From the company’s angle, it can be defined as the blended cost of capital that the company must pay for using the capital of both owners and debt holders.
What happens if the return is less than the WACC?
If the return offered by the company is less than its WACC, it is destroying value. Therefore, the investors may discontinue their investment in the company and look somewhere else for a better return. The following points will explain why WACC is important and how it is used by investors and the company for their respective purposes:
Are two companies with the same WACC risk equal?
No. This is because if we discounted both the companies with the acquiring company’s wacc, we would be assuming the two target companies “riskiness” is equal, and is also equal to the target company. This is, clearly, incorrect.