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Hi Sir.
Questions.
How does Point 1) increase shareholder wealth.
1) Average cost of capital is decreased by a recent finance decision.
If the cost of capital is lower, then the market value of the firm is higher (because we are discounting the free cash flows at the WACC). The increase in the market value of the firm goes to the benefit of the shareholders, so the market value of the shares will increase (which is the measure of shareholders wealth).
thanks for the explanation. But what type of finance decision would cause the average cost of capital to decrease?
Any resulting change in the gearing due to the method of financing will cause the WACC to change (unless, of course, there is no tax in which case in theory the WACC will stay contents. But this situation is very unlikely in P4.). Raising more debt finance will reduce the WACC because of the tax benefit associated with debt.
I really do suggest you watch my free lectures, including the free lectures going through Chapter 19 of the Paper F9 lecture notes because this is revision from Paper F9.
thanks Sir. I had a total mind freeze and completely missed that average cost of capital is WACC. I will check out the lectures for a refresh it has been a while.
Thanks
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