Will the Deflated WACC Please Stand Up? And the Real WACC Should Sit Down

Abstract

In a world with taxes, there is a small discrepancy between the deflated WACC WACCDef and the real wacc. This is due to the (1-T) term that is in the standard expression for the WACC applied to the Free Cash Flow (FCF). We compare different approaches for valuing nominal and real cash flows with the 1) nominal Weighted Average Cost of Capital, WACC, 2) real WACC, wacc, 3) inflated WACC, WACCInf and 4) deflated WACC, WACCDef. The cash flows are derived from financial statements that have been constructed in nominal prices. For consistency in valuation, we must use the deflated WACC rather than the real WACC to discount real cash flows, and the nominal WACC to discount nominal cash flows.

Keywords: Weighted Average Cost Of Capital, WACC, Firm Valuation, Capital Budgeting, Deflated WACC, Real WACC, Inflation

JEL Classification: D61, G31, H43