WACC: Definition, Misconceptions and Errors

8 Pages Posted: 5 Jun 2010 Last revised: 18 Nov 2015

Pablo Fernandez

University of Navarra - IESE Business School

Date Written: November 17, 2015

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 (November 17, 2015). Available at SSRN: https://ssrn.com/abstract=1620871 or http://dx.doi.org/10.2139/ssrn.1620871

Pablo Fernandez (Contact Author)

University of Navarra - IESE Business School ( email )

Camino del Cerro del Aguila 3
28023 Madrid
Spain
+34 91 357 0809 (Phone)
+34 91 357 2913 (Fax)

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

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