An Embarrassment of Riches: Winning Ways to Value with the WACC

13 Pages Posted: 17 Jul 2009 Last revised: 6 Apr 2019

See all articles by Joseph Tham

Joseph Tham

Educational Independent Consultant

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Date Written: April 4, 2019

Abstract

There are many different ways to calculate the Weighted Average Cost of Capital (WACC) and for the beginner the plethora of possibilities may be very confusing. We present a general framework for classifying the WACCs that are applied to the FCF and the CCF. For the moment, we avoid complexities. To facilitate the discussion, we classify the menagerie of WACCs along three dimensions. We hope that the structured framework assists the reader in making the correct decision with respect to the calculation of the cost of capital in practice. First, we present a qualitative discussion on the dimensions of the framework. Second, we specify the appropriate formulas and calculations for the cells in the framework.

At the outset, it is important to stress that this paper is concerned only with finite cash flows. In our judgment, it is best to discuss expressions for the cost of capital that are relevant to finite cash flows and this needs no further justification. In valuation, the continued use of cost of capital formulas (derived from cash flows in perpetuity), which are inappropriate for finite cash flows, is inexplicable and incomprehensible.

From a practical point of view, free cash flows are derived from financial statements, which are not constructed in perpetuity. At best, expressions for the cost of capital that are derived from cash flows in perpetuity may be reasonable approximations for finite cash flows. At worst, the results could be misleading.

Keywords: multi-period WACC, cost of capital

JEL Classification: D61, G31, H43

Suggested Citation

Tham, Joseph and Velez-Pareja, Ignacio, An Embarrassment of Riches: Winning Ways to Value with the WACC (April 4, 2019). Available at SSRN: https://ssrn.com/abstract=352180 or http://dx.doi.org/10.2139/ssrn.352180

Joseph Tham (Contact Author)

Educational Independent Consultant ( email )

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+573112333074 (Phone)

HOME PAGE: http://cashflow88.com/decisiones/decisiones.html

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