Return to basics: cost of capital depends on free cash flow

Ignacio Velez-Pareja ()

No 5097, Proyecciones Financieras y Valoración from Master Consultores

Abstract: Most popular corporate finance textbooks and practitioners present the WeightedAverage Cost of Capital WACC calculation as independent from the Free Cash Flow.It is a common use that practitioners calculate a WACC a priori and use it independentlyfrom the firm value (this is, from FCF). In this note we show that FCF affects WACC andthat this interrelationship creates circularity, but we show how it can be solved in a veryeasy way. There are two appendixes: one explaining the circularity issue and another one forderiving the proper formulation of the cost of equity.

Keywords: Weighted average cost of capital; WACC; firm valuation; capital budgeting; equity cost of capital; circularity (search for similar items in EconPapers)
JEL-codes: D61 G31 H43 (search for similar items in EconPapers)
Pages: 16
Date: 2008-10-13
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Persistent link: https://EconPapers.repec.org/RePEc:col:000463:005097

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