M
maz1987
Member
Explain why it may be difficult for companies to determine their cost of equity in order to measure the WACC.
The solution discusses investors using the cost of equity to discount future cashflows, but because companies do not know the cashflows used in the investors' calculation they cannot determine the return on capital required by investors.
However in my answer I focussed on the CAPM model and discussed the limitations with it i.e. the company cannot know how diversified the investors' portfolios are, they do not know which value of beta investors are using, do not know the market equity premium, etc. Would I have lost marks here for not mentioning that companies do not know the future cashflows used by investors? I guess I went for a more theoretical approach using the CAPM where the cashflows themselves don't determine the cost of equity rather than investors analysing the cashflows and the risks associated with them, and determining a required return on equity accordingly.
Thanks
The solution discusses investors using the cost of equity to discount future cashflows, but because companies do not know the cashflows used in the investors' calculation they cannot determine the return on capital required by investors.
However in my answer I focussed on the CAPM model and discussed the limitations with it i.e. the company cannot know how diversified the investors' portfolios are, they do not know which value of beta investors are using, do not know the market equity premium, etc. Would I have lost marks here for not mentioning that companies do not know the future cashflows used by investors? I guess I went for a more theoretical approach using the CAPM where the cashflows themselves don't determine the cost of equity rather than investors analysing the cashflows and the risks associated with them, and determining a required return on equity accordingly.
Thanks