WACC: Definition, Misconceptions, and Errors
The WACC is just the rate at which the Free Cash Flows must be discounted to obtain the same result as in the valuation using Equity Cash Flows discounted at the required return to equity (Ke) The WACC is neither a cost nor a required return: it is a weighted average of a cost and a required return. To refer to the WACC as the “cost of capital” may be misleading because it is not a cost. The paper includes 7 errors due to not remembering the definition of WACC and shows the relationship between the WACC and the value of the tax shields (VTS).Abstract
Contributor Notes
Pablo Fernández, PhD is a Professor of Financial Management and PricewaterhouseCoopers Chair of Corporate Finance, at the IESE Business School, University of Navarra, Camino del Cerro del Aguila 3. 28023 Madrid, Spain. He can be reached via email at fernandezpa@iese.edu.