ABV ABV Discount Rates & Capital Structure

Question 1

What does WACC stand for in the context of business valuation?

Accepted Answer

Weighted Average Cost of Capital

Answer

Weighted Average Capital Cost

Answer

Working Asset Capital Calculation

Answer

Weighted Adjusted Cash Contribution

Question 2

In a WACC calculation, why is the after-tax cost of debt used rather than the pre-tax cost?

Accepted Answer

Because interest expense is tax-deductible, reducing the effective cost of debt to the company

Answer

Because debt holders pay no taxes

Answer

Because the IRS requires after-tax reporting for all debt instruments

Answer

Because pre-tax cost of debt is unavailable from market data

Question 3

When using WACC to value a privately held company, how are the weights for debt and equity typically determined?

Accepted Answer

Using market value weights (or targeted capital structure) rather than book value weights

Answer

Using the company's book value of debt and equity only

Answer

Using the industry average debt-to-equity ratio always

Answer

Using the face value of all outstanding debt instruments

Question 4

What happens to WACC when a company increases its leverage (debt ratio), assuming no change in business risk?

Accepted Answer

WACC initially decreases due to the tax shield but may increase at high leverage due to financial distress costs

Answer

WACC increases because equity becomes riskier as leverage rises

Answer

WACC remains constant regardless of capital structure changes

Answer

WACC decreases indefinitely as more debt is added

Question 5

Which of the following is the correct formula for the after-tax cost of debt in a WACC calculation?

Accepted Answer

Kd = Pre-tax yield × (1 – Marginal Tax Rate)

Answer

Kd = (Interest Expense / Total Assets) × Tax Rate

Answer

Kd = Risk-Free Rate + Credit Spread – Tax Rate

Answer

Kd = Bond coupon rate / Book value of debt

Question 6

In business valuation, when is WACC preferred over the equity discount rate (cost of equity) as the discount rate?

Accepted Answer

When valuing invested capital (MVIC) using debt-free cash flows such as FCFF

Answer

When valuing equity directly using dividends only

Answer

When valuing debt-free, cash-free earnings

Answer

When the company has no debt outstanding