WACC - relationships and considerations

Relationships

• The market determines our cost of debt and cost of equity
• When the cost of debt is cheaper than of equity, increasing our leverage will reduce our WACC as seen in this example. There has to be an optimum debt to equity ratio for our firm
• Our stock price, and our ability to raise funds issuing stock or buying assets for stock, is more unpredictable than cost of debt. In good times, the investors' favorable expectations about our stock price growth, and our stocks's rising price, can be used to our advantage

Considerations

After some thought and a few phone calls, "the boss" prepared two similar questions for the strategy steering committee. The lead in to be:

• Should our expected return be based on today's market expectations or historical performance? And, the more specific,
• Should we use our industry's average weighted cost of capital or an estimate of our firm's future cost of capital (based on our expectations for future borrowing costs and stock prices)?

She also wondered again, why was the CFO was not leading this discussion ...