Weighted Average Cost of Capital (WACC) and Cost of Equity Quiz

WACC represents the blended cost of all capital sources, considering their weights in the capital structure.

Inventory cost is not part of WACC, which focuses on financing components like equity and debt.

'E' stands for Equity in the WACC formula, representing the market value of a company's equity.

'D' stands for Debt in the WACC formula, representing the market value of a company's debt.

'Re' stands for Return on Equity in the WACC formula, representing the expected return for equity holders.

CAPM calculates equity cost based on risk-free rate, beta (systematic risk), and market risk premium.

A higher market risk premium raises the perceived risk, increasing the cost of equity for investors.

WACC is the weighted sum of the cost of equity and after-tax cost of debt, considering their respective proportions in the capital structure.

Arithmetic Mean Return is not a valid method for estimating the cost of equity; CAPM and Gordon Growth Model are commonly used.

Beta measures a stock's sensitivity to market movements, indicating its systematic risk in the CAPM model.

Higher taxes reduce the after-tax benefit of debt, making it more expensive and raising the cost of debt in WACC.

WACC assumes a fixed capital mix, which may not hold in dynamic business environments, impacting investment decisions.

The Modigliani-Miller theorem assumes that taxes do not impact the optimal capital structure, focusing on other factors like bankruptcy costs.