Disadvantages of WACC


N's spirit Basic MBA > Disadvantages of WACC

Disadvantages of WACC

WACC would be perfect for calculating present value of cash flow by DCF method in terms of logic so it is useful to make a decision on something financial point of view. However, WACC has actually some disadvantages. This page explains them.


Disadvantage of WACC 1 (Inconsistency of tenses)

One of disadvantages of WACC is that Beta is used when estimating CAPM. WACC is used with "future" cash flow generated by a company, which means all factors should show "future" situation.

However, risk premium of Beta refers to "historical" number, which means inconsistency of tenses. This is because future Beta and risk premium cannot be easily estimated, furthermore, it is almost impossible.


Disadvantage of WACC 2 (Constant D/E ratio)

Another disadvantage of WACC is that WACC is calculated by weighted average between debt cost and equity cost. It means that WACC is calculated given D/E ratio change during a period.

However, it would be impossible to assume that D/E ratio is constant forever and to estimate future WACC because future D/E ratio will be influenced by some unknown factors.

Therefore, WACC is used when it is assumed that D/E ratio keeps constant during a period.


WACC


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Finance
Principle of Finance
FCF (Free Cash Flow)
DCF (Discount Cash Flow)
WACC
Beta
Unlevered Beta
IRR
Terminal Value
Disadvantages of WACC
APV (Adjusted present value) Method
Making Portfolio and Diversification of Risk 1
Making Portfolio and Diversification of Risk 2
Return analysis by DCF 1
Return analysis by DCF 2
Important Indicator of DCF
Optimized Debt Equity Ratio
Tax Shield by Debt
Types of Debt
Policy of Dividend
Relationship between Policy of Dividend & Stock Price
Relationship between Own Shares Purchase & Stock Price
Investment to raise Stock Price
Bond
Coupon-Bearing Bond
Discount Bond
Bond with Warrant
Comparison of Yield Rate among Several Bonds
Securitization
Project Finance
M&A
Effect of M&A
Synergy Analysis
Financing in M&A
Process of Purchasing Stock Price in M&A
Types of Selling Business
Spinoff
Tracking Stock
Curve Out
LBO (Leveraged Buy Out)
MBO (Management Buy Out)
PPA (Purchase Price Allocation)
PMI (Post Merger Integration)


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