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A Losing Formula

Volatile financial markets can wreak havoc with your cost-of-capital calculations — and possibly skew your investment decisions and financial results.

Randy Myers, CFO Magazine
May 1, 2009

Calculating WACC

Another challenge in accurately calculating WACC in this environment (in addition to unsustainably low "risk-free" rates) is the preponderance of firms whose debt is now considered "distressed". How can you determine the cost of debt for Chrysler right now, when there is effectively no market clearing price for their bonds? Struggling retailers with small market caps and low/no activity in the bond markets (ie, Borders group) are another emerging class of firms where the cost of debt is effectively unknowable. Given that so many of the variables that influence WACC are gyrating wildly right now, I typically use to give me a rough initial value for a firm's WACC, but then I enter in my own adjustments for most of the drivers (ie, I typically adjust the cost of debt up significantly, and lower the value of the expected market returns). Even before the past year's market volatility, I never thought of WACC as a precise, constant figure, but it is more important than ever to reevaluate a firm's WACC frequently.

Posted by Mitch Hollberg | May 01, 2009 11:44 pm

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