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WACC Concept and Discussion

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a. What is Weighted Average Cost of Capital (WACC)? Identify TWO (2) factors that affect
the WACC of a company.

1- Using debt can help reduce the agency problem that may arise between the
management of a company and its shareholders. Explain.

2- Explain the effects of the following on the company's weighted average cost of capital:
i) Floatation cost
ii) Reduction in corporate tax

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Solution Summary

This solution includes a general discussion on WACC (Weighted Average Cost of Capital) and some of the factors that affect the WACC of a company, such as cost of debt, cost of common equity, flotation, corporate tax, and agency conflict. Attached in Word.

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Locating an Automobile Plant

See attached file.

China is a manufacturing superpower. Assume that you are CFO of an automobile manufacturer looking to build a $U.S.800 million plant in China. You are discussing this project with your spouse, who is intelligent, but has no background in finance.

1. Your discussion should begin with a clear and logical step-by-step explanation of the theory behind the concept of "required return" on proposed capital investments. Explain how cost of equity, cost of debt, WACC, and allowances for various risk factors are involved in determining the "required return" on proposed international capital investments.

2. Discuss each of the main risk factors that should be allowed for in addition to WACC in order to determine the appropriate required return on this capital investment opportunity.

3. Make a reasonable estimate of the required return, starting with a 12% weighted average cost of capital for the U.S. auto manufacturer, and adding reasonable estimated percentages for each of the separate risk elements you can foresee.

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