Identify and briefly explain three conditions which have to be satisfied before the use of the weighted average cost of capital (WACC) can be justified.

CPA-Financial-Management-Section-3 Revision kit

Required conditions for using the WACC
• The WACC assumes the project is a marginal, scalar addition to the company‟s existing activities, with no overspill or synergistic impact likely to disturb the current valuation relationships.
• It assumes that project financing involves no deviation from the current capital structure (otherwise the MCC should be used.). The financing mix is similar to existing capital structure.
• Using the WACC implies that any new project has the same systematic or operating risk as the company‟s existing operations. This is possibly a reasonable assumptions for minor projects in existing areas and perhaps replacements but hardly so for major new product developments.

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