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26 January, 11:19

Suppose a firm estimates its WACC to be 10%. Should the WACC be used to evaluate all of its potential projects, even if they vary in risk? If not, what might be "reasonable" costs of capital for average-, high-, and low-risk projects?

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  1. 26 January, 11:22
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    The WACC will be 10% for average risk

    below when the risk is low

    and above 10% when the risk is higher than average

    as the cost of capital (required return from the stockholders) will increase pushing the WACC higher

    Explanation:

    As the WACC is composed by the cost of debt and the cost of equity a higher risk will require a better return for the investor thus, the equity proportion that determinates the WACC will change along the project risk.
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