What is a **discount rate** __fundamentally__ based on?

All discount rates are based on the **riskiness of the asset** being price

What is the __financial definition__ of **risk**?

In finance, risk refers to the **degree of uncertainty and/or potential financial loss **inherent in an investment decision.

What is the __definition__ of **WACC**?

The WACC is the **expected return on a portfolio comprised of the debt and equity** in the firm's capital structure.

What is the process for __calculating__ **WACC**?

1. **Identify all of the sources of long-term capital** that have been used to finance operations.

2. **Adjust each component cost of capital** for the risk specific to it.

3. **Use nominal rates of return** because we forecast expected actual future cash flows.

4. **Weight each component cost of capital** using target market value weights.

5. **Calculate a weighted average of the marginal costs **of all sources of capital - debt, equity, etc.

What is the **equation** for __Weighted Average Cost of Capital __(**WACC**)?

**True/False:**

A firm's capital structure determines how it allocates cash flows between creditors and shareholders.

**True**

Does the **use of debt** __impact__ the **free cash flow** a business generates?

**No!**

The free cash flows are allocated between creditorsand shareholders. Using more or less debt doesn't change the amount of cash the business generates.

Why aren't **non-interest baring debts** __included__ in the **WACC calculation**?

Non-interest-bearing liabilities, such as accounts payable, are excluded from the calculation of WACC to avoid inconsistencies and simplify

the calculation.

**Calculate the WACC**

A firm has a long-run debt-asset ratio of 40%, the marginal corporate tax rate is 20%, and its bonds have a AA bond rating. If the current yield on a AA bond of comparable risk is 5% and the required return on equity is 10%.

**What is the companies overall WACC?**

WACC = (2/5)*(4/5)*(1/20) + (3/5)*(1/10)

**.: WACC = 7.6%**

**Calculate the WACC**

If a firm has a cost of capital of 8% when using 40% debt, would the WACC go up or down if the company shifted to using 60% debt?

**Note: **

Cost of Debt - 5%

Cost of Equity - 10%

WACC would **go down**