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    Ghaundar's Avatar
    Ghaundar Posts: 3, Reputation: 1
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    #1

    Dec 6, 2007, 01:20 PM
    Weighted average cost of capital
    The weighted average cost of capital is used as a discount rate because
    A)It is an indication of how much the firm is earning overall.
    B)As long as the cost of capital is earned, the common stock value of the firm will be maintained.
    C)It is comparable to the prevailing market interest rates.
    D)Returns below the cost of capital will cover all fixed costs associated with capital and provide an excess return to stockholders.

    Now I understand the homework rules and this one is killing me; I think the answer is B but my answer is only grounded on the fact that A, C and D just don't make a whole lot of sense to me regarding discount rate.

    Thanks in advance.
    Jayblaze's Avatar
    Jayblaze Posts: 4, Reputation: 1
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    #2

    Dec 6, 2007, 01:48 PM
    Ghaundar,

    WACC basically is the return firms MUST earn on their existing assets in order to keep their stock prices level (constant) and satisy creditors and shareholders. I hope that helps you.
    Ghaundar's Avatar
    Ghaundar Posts: 3, Reputation: 1
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    #3

    Dec 6, 2007, 02:15 PM
    Quote Originally Posted by Ghaundar
    The weighted average cost of capital is used as a discount rate because
    A)It is an indication of how much the firm is earning overall.
    B)As long as the cost of capital is earned, the common stock value of the firm will be maintained.
    C)It is comparable to the prevailing market interest rates.
    D)Returns below the cost of capital will cover all fixed costs associated with capital and provide an excess return to stockholders.

    Now I understand the homework rules and this one is killing me; I think the answer is B but my answer is only grounded on the fact that A, C and D just don't make a whole lot of sense to me regarding discount rate.

    Thanks in advance.
    So it really sounds more like B. I guess the addition of the discount rate phrase had me confused.
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