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Dear Moffat,
Hope you are well and thank you for your nice lectures.I am a little confused about using WACC.
Suppose the current WACC of a comapny is 10%. The Company intends to invest in a new project. The WACC of the money required for this project is 20%. Suppose if the company invests in this project, the overall WACC of the company increases from 10% to 13%.Now my question is which WACC should be used for this project appraisal? The WACC of the specific project (20%) or the overall WACC of the Company (13%).
According to your lectures as far as I understood the answer to the above questions is using the WACC for the specific project (20%). Why? it is a little vague for me. Why we should not use the overall WACC (13%) ? Because although the company may invest in different projects with different cost of capitals, but the OVERALL WACC is important! Am I wrong?
Thanks
We would use a WACC for the project because the return required depends partly on the riskiness of the project and partly on the way the project is financed.
However this cannot be asked for in Paper FM. You can only be asked to calculate a project specific cost of equity as I show in my lectures.
It is asked for in Paper AFM, but then we use a technique called ‘adjusted present value’ which is not in the syllabus for Paper FM.
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