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A note resolving the debate on “The weighted average cost of capital is not quite right”

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  • Keef, Stephen P
  • Khaled, Mohammed S
  • Roush, Melvin L
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    Abstract

    Miller (2009a) derives a weighted average cost of capital for the special case where the cash flows to equity and the cashflows to debt are annuities. The paper attracts debate. We show that the weighted average cost of capital is redundant in a world where interest paid is not tax deductible. The required rate of return on unlevered equity will consistently and reliably estimate the net present value of any project no matter the idiocyncratic beliefs of the analyst as to the year-by-year leverage of the project, or of the firm. We recommend that the weighted average cost of capital method is discarded. Our recommendation also applies to a world where interest paid is tax deductible.

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    File URL: http://researcharchive.vuw.ac.nz/handle/10063/2003
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    Bibliographic Info

    Paper provided by Victoria University of Wellington, School of Economics and Finance in its series Working Paper Series with number 2003.

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    Date of creation: 2011
    Date of revision:
    Handle: RePEc:vuw:vuwecf:2003

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    Postal: Alice Fong, Administrator, School of Economics and Finance, Victoria Business School, Victoria University of Wellington, PO Box 600 Wellington, New Zealand
    Phone: +64 (4) 463-5353
    Fax: +64 (4) 463-5014
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    Web page: http://www.victoria.ac.nz/sef
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    Related research

    Keywords: WACC; finite life; discount rate; net present value; leverage;

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    1. 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.
    2. 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.
    3. Pierru, Axel, 2009. ""The weighted average cost of capital is not quite right": A comment," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(3), pages 1219-1223, August.
    4. Myers, Stewart C, 1974. "Interactions of Corporate Financing and Investment Decisions-Implications for Capital Budgeting," Journal of Finance, American Finance Association, vol. 29(1), pages 1-25, March.
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