When one conducts a discounted cash flow analysis, why is the WACC used as the discount rate?
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Last edited by midgetspinner; 25-01-2017 at 22:20.
- 25-01-2017 22:19
- 26-01-2017 04:33
you find a company via two sources on your balance sheet - equity+debt (liabilities), given you are valuing the whole company as cash is generated through assets, both the rate of return for equity and debt are taken into account in the WACC calculation. so it's the weighted average of
1) equity - cost of equity = rf + beta*(return on market - rf)
2) cost of debt debt = interest rate Corp pays on debt*(1-Corp tax rate)
then your weights is your capital structure so (1) equity/total capital and (2) debt/total capital
it provides a good approximation to determine discount rate and subsequently enterprise value, taking into account the risk streams from all sources of funding.Last edited by gr8wizard10; 26-01-2017 at 04:38.