IDEAS home Printed from https://ideas.repec.org/a/jfr/afr111/v2y2013i2p36.html
   My bibliography  Save this article

WACC Calculations in Practice: Incorrect Results due to Inconsistent Assumptions - Status Quo and Improvements

Author

Listed:
  • Matthias C. Grüninger
  • Axel H. Kind

Abstract

This paper argues that in practical applications the weighted average cost of capital (WACC) is often incorrectly estimated due to the simultaneous use of two inconsistent input parameters- (i) a beta of debt equal to zero when transforming asset betas into equity betas (beta levering) and (ii) a cost of debt above the risk-free interest rate when calculating the WACC. The paper discusses and quantifies the consequences of this inconsistency and offers viable solutions. By replacing the cost of debt with the risk-free rate, a more accurate WACC is calculated and the estimation of the cost of debt becomes obsolete. Furthermore, the paper presents a solution to obtain the correct WACC without increasing the calculation’s complexity.

Suggested Citation

  • Matthias C. Grüninger & Axel H. Kind, 2013. "WACC Calculations in Practice: Incorrect Results due to Inconsistent Assumptions - Status Quo and Improvements," Accounting and Finance Research, Sciedu Press, vol. 2(2), pages 1-36, May.
    • Handle: RePEc:jfr:afr111:v:2:y:2013:i:2:p:36
    as

    Download full text from publisher

    File URL: https://www.sciedupress.com/journal/index.php/afr/article/download/2694/1550
    Download Restriction: no
    File URL: https://www.sciedupress.com/journal/index.php/afr/article/view/2694
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. André Farber & Roland Gillet & Ariane Szafarz, 2005. "A general formula for the WACC," Working Papers CEB 05-012.RS, ULB -- Universite Libre de Bruxelles.
    2. Richard S Ruback, 2002. "Capital Cash Flows: A Simple Approach to Valuing Risky Cash Flows," Financial Management, Financial Management Association, vol. 31(2), Summer.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Tomáš Buus, 2014. "Cost of Financial Distress in the Cash Flow Model of Capital Structure [Náklady finanční tísně v cash flow modelech kapitálové struktury]," Český finanční a účetní časopis, Prague University of Economics and Business, vol. 2014(3), pages 46-58.
    2. Fernandez, Pablo, 2006. "A general formula for the WACC: A correction," IESE Research Papers D/663, IESE Business School.
    3. Christian Koziol, 2014. "A simple correction of the WACC discount rate for default risk and bankruptcy costs," Review of Quantitative Finance and Accounting, Springer, vol. 42(4), pages 653-666, May.
    4. Shigufta Hena Uzma & J.P. Singh & Naveen Kumar, 2010. "Discounted Cash Flow and Its Implication on Intangible Valuation," Global Business Review, International Management Institute, vol. 11(3), pages 365-377, October.
    5. Fernandez, Pablo, 2007. "A more realistic valuation: APV and WACC with constant book leverage ratio," IESE Research Papers D/715, IESE Business School.
    6. Magni, Carlo Alberto, 2009. "Splitting up value: A critical review of residual income theories," European Journal of Operational Research, Elsevier, vol. 198(1), pages 1-22, October.
    7. Pierru, Axel, 2009. ""The weighted average cost of capital is not quite right": A rejoinder," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(4), pages 1481-1484, November.
    8. Ralf Diedrich & Stefan Dierkes & Hans-Christian Gröger, 2022. "A note on the cost of capital with fixed payout ratios," Review of Quantitative Finance and Accounting, Springer, vol. 59(4), pages 1559-1575, November.
    9. Denis Babusiaux & Axel Pierru, 2009. "Investment project valuation : A new equity perspective," Working Papers hal-02469464, HAL.
    10. Cooper, Ian A. & Nyborg, Kjell G., 2006. "The value of tax shields IS equal to the present value of tax shields," Journal of Financial Economics, Elsevier, vol. 81(1), pages 215-225, July.
    11. Peter Brusov & Tatiana Filatova & Natali Orekhova & Veniamin Kulik & She-I Chang & George Lin, 2021. "Generalization of the Modigliani–Miller Theory for the Case of Variable Profit," Mathematics, MDPI, vol. 9(11), pages 1-24, June.
    12. Jennergren, L. Peter, 2011. "Firm Valuation with Operating Leases," SSE/EFI Working Paper Series in Business Administration 2011:3, Stockholm School of Economics, revised 30 May 2011.
    13. Peter Brusov & Tatiana Filatova & Natali Orekhova, 2023. "Influence of Method and Frequency of Profit Tax Payments on Company Financial Indicators," Springer Books, in: The Brusov–Filatova–Orekhova Theory of Capital Structure, chapter 0, pages 241-264, Springer.
    14. Peter Reichling & Anastasiia Zbandut, 2017. "Costs of capital under credit risk," FEMM Working Papers 170003, Otto-von-Guericke University Magdeburg, Faculty of Economics and Management.
    15. Roland Gillet & Ariane Szafarz & André Farber, 2007. "A general formula for the WACC : A Reply," Post-Print hal-03716097, HAL.
    16. Fernandez, Pablo, 2003. "Equivalence of ten different methods for valuing companies by cash flow discounting," IESE Research Papers D/524, IESE Business School.
    17. Jennergren, L. Peter, 1998. "A Tutorial on the Discounted Cash Flow Model for Valuation of Companies," SSE/EFI Working Paper Series in Business Administration 1, Stockholm School of Economics, revised 13 Dec 2011.
    18. H. Qi & Y. A. Xie, 2016. "Cost of capital: spot rate or forward rate?," Applied Economics, Taylor & Francis Journals, vol. 48(40), pages 3804-3811, August.
    19. Peter Brusov & Tatiana Filatova & Natali Orekhova, 2023. "Generalization of the Brusov–Filatova–Orekhova Theory for the Case of Variable Income," Springer Books, in: The Brusov–Filatova–Orekhova Theory of Capital Structure, chapter 0, pages 265-290, Springer.
    20. Zurita, Salvador & Castillo, Augusto & Niño, Jorge, 2019. "Inflation, tax integration and company valuation: The Latin American case," Journal of Business Research, Elsevier, vol. 105(C), pages 370-380.

    More about this item

    JEL classification:

    • R00 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - General - - - General
    • Z0 - Other Special Topics - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:jfr:afr111:v:2:y:2013:i:2:p:36. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Sciedu Press (email available below). General contact details of provider: https://edirc.repec.org/data/cepflch.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.