More cash = higher WACC?

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As far as I understand, having more cash on your balance sheet would not affect your WACC. Cost of equity is calculated using CAPM which does not take your cash into consideration. Also, more cash would lower the riskiness of your debt given that you have more cash to burn through to cover your interest payments than Company B which would lead to a lower cost of debt if Company A's capital structure is identical to Company B.

Definitely an interesting concept. Gonna try to take a stab here...

Assuming company A and company B are identical and have the same amount of debt, the company with more cash should have a higher market value. Because of this, the cost of equity will have a larger effect on WACC. Though this should lead to a higher discount rate (since cost of equity > cost of debt), more cash on the balance sheet will lower your beta and overall cost of equity. Using the formula LeveredBeta = UnleveredBeta * (1+(1-T)(D/E) will demonstrate this (you will have a lower D/E ratio). Plug the lower Beta into the CAPM model, and you will come out with a lower CoE.

Not entirely sure about the end result on WACC but these are just my thoughts. I would imagine WACC wouldn't change and a DCF will yield the same EV, but after accounting for net debt the market value would be different by the difference in cash.

depends on how the cash is acquired. if it is through successful normal business operations than it has no effect. if its financed via raising through debt or equity then yes it can contribute to a high wacc

cost of debt is is cheaper than cost of equity only to a certain point. the risk in debt is obviously higher, but it comes to a point in which there is so much debt in the capital structure that the cost of debt exceeds it as debt holders will want a huge return on their investment to offset all this existing debt

debt is cheaper due to it being superior to equity in the event of liquidation, debt's interest payments are tax deductible

a huge cash balance will give you a lower EV.

The opportunity cost (to shareholders) of leaving cash on the balance sheet = cost of equity so yes WACC is higher because of inefficient capital allocation (if cash is indeed excess).

Question here: what do you mean when you say the companies are identical except cash? do you mean that the equity and debt are identical but the asset composition differs? Couldn't it in theory be that the equity and debt are identical if the company with less cash had purchased assets for its cash?

I politely disagree with the above answers. Here’s what I think will happen:

Enterprise value may well be marginally higher (arguably) in the case where excess cash balance is higher. Your net debt number will be lower and so will be the interest rate on that debt (it’s much safer). Cost of equity should also be slightly lower since there isn’t a lot of stress on equity (in terms of more senior security and corresponding interest payments). Though also to keep in mind: the % proportion of debt and equity may now be whacked in favor of equity, so the WACC could end being slightly higher depending upon your assumptions for the new cost of debt and cost of equity.

That said, when you arrive at this New enterprise value (even if it is slightly lower), you’ll subtract the net debt number (which is of course inclusive of cash), so your equity value will be higher.

There’s an argument that Enteprise value remains fundamentally the same (regardless of capital structure imposed) with the value of the firm either tilting in favor of equity holders or debt holders

M&M theory