Title: Why do we still put up with WACC?
Authors: Sercu, Piet
Issue Date: 2007
Publisher: K.U.Leuven - Faculty of Economics and Applied Economics
Series Title: DTEW - AFI_0707 pages:1-16
Abstract: WACC , being designed for situations with perpetual constant leverage, overestimates the NPV when the project's life is finite. The reason is that it sets the weight of the PV 'ed tax shields at too high a level initially and ignores the fact that this weight should fall even further as the project matures. As a result, initial risk is underestimated, and subsequent further rises in risk are overlooked. For realistic projects of 5-7 years the overstatement of the PV of the tax shield typically exceeds 50%. One needs 10-year horizons for the error to drop to 40%, and 20 years for a drop to 25%. In contrast, ANPV can correctly handle not only any deterministic cash flow pattern or capital structure, but, after a minor tweak in the programming, also borrowing strategies where the loan amount changes proportionally with gross present value--- the situation supposedly best solved with WACC : one just needs to apply NPV() twice.
Publication status: published
KU Leuven publication type: IR
Appears in Collections:Research Center International Finance, Leuven

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