WACC: Definition, Misconceptions and Errors

8 Pages Posted: 5 Jun 2010 Last revised: 26 May 2019

Date Written: May 24, 2019

Abstract

The WACC is just the rate at which the Free Cash Flows must be discounted to obtain the same result as in the valuation using Equity Cash Flows discounted at the required return to equity (Ke).

The WACC is neither a cost nor a required return: it is a weighted average of a cost and a required return. To refer to the WACC as the “cost of capital” may be misleading because it is not a cost.

The paper describes 7 valuation errors caused by incomplete understanding of the WACC, and shows the relationship between the WACC and the value of the tax shields (VTS).

Keywords: WACC, Required Return to Equity, Value of Tax Shields, Company Valuation, APV, Cost of Debt

JEL Classification: G12, G31, G32

Suggested Citation

Fernandez, Pablo, WACC: Definition, Misconceptions and Errors (May 24, 2019). Available at SSRN: https://ssrn.com/abstract=1620871 or http://dx.doi.org/10.2139/ssrn.1620871

Pablo Fernandez (Contact Author)

IESE Business School ( email )

Avenida Pearson 21
Barcelona, 08034
Spain
+34 91 357 0809 (Phone)
+34 91 357 2913 (Fax)

HOME PAGE: http://web.iese.edu/PabloFernandez/

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