Your manager just finished computing your firm\'s weighted average cost of capit
ID: 2726226 • Letter: Y
Question
Your manager just finished computing your firm's weighted average cost of capital. He is relieved because he says that he can now use that cost of capital to evaluate all projects that the firm is considering for the next four years. Evaluate that statement.
Maltese Falcone, Inc., has not checked its weighted average cost of capital for four years. Firm management claims that since Maltese has not had to raise capital for new projects since that time, they should not have to worry about their current weighted average cost of capital since they have essentially locked in their cost of capital. Critique that statement.
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Explanation / Answer
He can be relieved on the ground that weighted average cost of capital has fixed for the next 4 years and would be used for evaluating all the project.
weighted average cost of capital is subject to change in future due to change in the market value of the securities. on the basis of book value weight he can fix the cost of capital but more appropriate is to calculate weighted average cost of capital on the basis of market value of firm and securities as the market prices of securities keep on changing so as a result weighted average cost of capital would also be changed so you can not be assured that weighted average cost of capital is fixed.
a more appropriate approach to weighted average cost of capital is that it should be calculated with market value basis. market value of the firm denotes the real market value of all the securities and risk assosciated with the securities so that earnings would be discounted at a rate equal to investors required rate of return.
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