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Good Evening Chris,
I’m getting ready for the MCS, that’s why the weird questions.
What is the effect of the share price increase on WACC?
My logic says that if share prices increase that means the shareholders have more confidence in higher profits, which in turn means they will have higher opportunity costs of alternative investments not chosen in favour of our shares, therefore cost of equity increases and WACC increases.
However this train of thought must have a fault somewhere because share price increase is good and WACC increase is bad, so they must move in opposite directions.
So how does it work?
Hi,
If the share price increases then we are weighting the WACC towards the cost of equity and so the WACC will increase. This increase in WACC is then reflective of that higher price as if the price is increasing we are getting a higher return. Don’t think of the high WACC as a bad sign, think of it as shareholders requiring a higher return and in using the higher WACC we ensure we only take on projects that deliver these higher returns.
Thanks
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