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"The weighted average cost of capital is not quite right": A comment

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  • Pierru, Axel
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    Abstract

    In this journal, Miller [Miller, R. A. (2009). The weighted average cost of capital is not quite right. The Quarterly Review of Economics and Finance, 49, 128-138] argues that the standard WACC formula fails to correctly remunerate shareholders and bondholders. This is proved by considering a project yielding a zero net present value. In this comment, we prove that this apparent failure of the standard WACC approach simply stems from the fact that, in Miller's example, the project's debt ratio is implicitly assumed constant throughout the project's life, whereas it is not. We also show that the suggested modified WACC formula is not relevant. More generally, we emphasize that, in any year, a project's debt ratio must be defined with respect to the economic value of the project.

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    File URL: http://www.sciencedirect.com/science/article/B6W5X-4TB18B1-1/2/2197f23448029b75f961dadbfbb29299
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    Bibliographic Info

    Article provided by Elsevier in its journal The Quarterly Review of Economics and Finance.

    Volume (Year): 49 (2009)
    Issue (Month): 3 (August)
    Pages: 1219-1223

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    Handle: RePEc:eee:quaeco:v:49:y:2009:i:3:p:1219-1223

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    Web page: http://www.elsevier.com/locate/inca/620167

    Related research

    Keywords: WACC Cost of capital Debt ratio Leverage ratio;

    References

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    1. Linke, Charles M. & Kim, Moon K., 1974. "More on the Weighted Average Cost of Capital: A Comment and Analysis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 9(06), pages 1069-1080, December.
    2. Miles, James A & Ezzell, John R, 1985. " Reformulating Tax Shield Valuation: A Note," Journal of Finance, American Finance Association, vol. 40(5), pages 1485-92, December.
    3. Miller, Richard A., 2009. "The weighted average cost of capital is not quite right: Reply to M. Pierru," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(3), pages 1213-1218, August.
    4. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
    5. Miller, Richard A., 2009. "The weighted average cost of capital is not quite right," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(1), pages 128-138, February.
    6. Miles, James A. & Ezzell, John R., 1980. "The Weighted Average Cost of Capital, Perfect Capital Markets, and Project Life: A Clarification," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(03), pages 719-730, September.
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    Cited by:
    1. Keef, Stephen P. & Khaled, Mohammed S. & Roush, Melvin L., 2012. "A note resolving the debate on “The weighted average cost of capital is not quite right”," The Quarterly Review of Economics and Finance, Elsevier, vol. 52(4), pages 438-442.
    2. Keef, Stephen P & Khaled, Mohammed S & Roush, Melvin L, 2011. "Miller's (2009) WACC model: An extension," Working Paper Series 1995, Victoria University of Wellington, School of Economics and Finance.
    3. Keef, Stephen P & Khaled, Mohammed S & Roush, Melvin L, 2011. "A note resolving the debate on “The weighted average cost of capital is not quite right”," Working Paper Series 2003, Victoria University of Wellington, School of Economics and Finance.

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