Chapter 23, Problem 5CT

Summary Introduction

Weighted Average Cost of Capital (WACC):

The weighted average cost of capital is the rate that a firm is expected to pay on average to all of its shareholders to finance its assets. WACC is the firm’s cost of capital and is dictated by the external market of the firm. It represents the minimum return that a firm ought to earn on an existing asset base in order to satisfy its creditors, owners, and other providers of capital, or else they would invested somewhere else.

Market-value based weights are used in the calculation of Weighted Average Cost of Capital. Book value shows the historical costs of a firm while market values are forward-looking and are based on what the assets of a firm are anticipated to yield in the future. Investors measure the performance of the firm on the basis of the market value of its assets, instead of the book value.

To determine:

The assumptions necessary to value foreign cash flows using the domestic WACC method.