F2 Advanced Financial Reporting Exam Sample Question

Question No: 1

When can WACC be used as a discount rate?

The WACC is often used as a discount rate when using net present value or internal rate of return calculations. However, this is only appropriate if the following conditions are met:
(1) The capital structure is constant. If the capital structure changes, the weightings in the WACC will also change.
(2) The new investment does not carry a different business risk profile to the existing entity's operations.
(3) The new investment is marginal to the entity. If we are only looking at a small investment then we would not expect any of ke, kd or the WACC to change materially. If the investment is substantial it will usually cause these values to change.

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