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Dear John,
Hope you keepjng good today.
Apologies for having mistaken you for Mike, yesterday. Actually I have been following his lectures for a while and been communicating to him quite often, so it was my reflex that called you Mike. Serious apologies.
I have a general query on WACC. Can you please state me the applications and uses of WACC. 1 of them is certainly that we may need it for investment appraisal, but what other purposes is WACC used for?
Also when it comes to deciding on sources of finance for new investment, how can we decide on what is the best source? And does WACC influence the decision on what sources we are going to opt for?
Thanks,
AamirThe WACC is the overall cost of finance to the company and therefore investments need to generate a return higher than the WACC, which is why we discount at the WACC.
You cannot be asked for the best source of finance – in practice it depends on my factors, such as the ease of raising the money, whether or not the money will need to be repaid (share finance is not repaid, debt finance will have to be repaid), the effect on the EPS, the effect on risk for the shareholders etc etc.. However a major factor will obviously be the cost of the finance and in this regard the lower the resulting WACC the better. (In the traditional theory there will be a best level of gearing; with M&M without tax then the WACC is not affected; with M&M with tax then the more debt finance the better).
All of this is covered in my lectures and notes on sources of finance.
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