Q:
What Are the Limitations of WACC?
A:
Quick Answer
According to Financial Management, the Weighted Average Cost of Capital (WACC) formula does not account for the financial risk that comes with raising capital for projects. It also assumes that the costs of capital will and inputs will not fluctuate.
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Using the WACC can still be useful, according to Financial Management. WACC is the minimum rate of return required to create value for firms. Investors will have sufficient reason to continue investing in a given firm if it earns a return equal to or more than the WACC. The formula is: WACC = ke[VE ÷ (VE + VD)] + kd(1 – t)[VD ÷ (VE + VD)].
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