Manipulate WACC?

Gekko21:

Yes you can, but you need to understand about WACC and CAPM is that while they have some practicality and do serve as a possible "benchmark" there is a large gap between those ideas and the real world. There are a whole host of factors that drive stock prices, but you will not see "stock X up 4% because of WACC went down" nor is all business decisions as straight line item as one of your business book examples.

It is up to the business managers to make decisions about their capital structures based on current market factors, the individual firms needs, potential future needs, or just the managers own preference. It could be one or a combination of those needs.

Also, even though shorter term debt has a lower yield do not fool yourself into thinking that it is "safer". Different business models have more preferable funding models; Banks and real estate firms borrow short to lend long, tech start-up want equity rather than debt, high cap ex businesses want longer term financing. While shorter term debt fund raising is certainly cheaper, problems arise when there is a credit crunch (ie 2007) and all of a sudden the firm can't roll it's debt over and has a serious liquidity problem. A firm that has locked in longer term financing (or has a more balanced term structure) doesn't need to worry as much about the credit crunch of today.

Thanks for your answer. I under stand how CAPM and WACC works (at least I though I did until I actually tried to calculate one myself :), but in a DCF, WACC plays a crucial part (at least as important as TV). If the CFO can manipulate it how would that effect the DCF?

Thanks you, Chris

Sarbane's Moxie:

Assuming you could artificially lower WACC (barring refi risk or anything like that), it would just make it an inappropriate discount rate to find PV of ULFCFs. You should theoretically use the discount rate that most accurately reflects the time value of money and uncertainty of a firm's future cash flows, regardless of whether you use WACC to calculate it.

Thanks for your answer.

So basically WACC can be manipulated because even though refi risk will have an immediate impact on the stock price it will not (at least not in the short run) have an impact the the CAPM - used to find the cost of equity.

So in the end it boils down to:

CAPM uses beta which is calculated using historical data and thus lags behind the actual cost of equity (which would be, do to refi risk, much higher)

Is that correct?