Uday Kumar Jagannathan – Ramaiah University of Applied Sciences, New BEL Road, Bangalore, India 560058
DOI: https://doi.org/10.31410/ERAZ.2019.125
5th International Conference – ERAZ 2019 – KNOWLEDGE BASED SUSTAINABLE DEVELOPMENT, Budapest – Hungary, May 23, 2019, CONFERENCE PROCEEDINGS
Published by: Association of Economists and Managers of the Balkans – Belgrade, Serbia
Conference partners: Faculty of Economics and Business, Mediterranean University, Montenegro; University of National and World Economy – Sofia, Bulgaria; Faculty of Commercial and Business Studies – Celje, Slovenia; Faculty of Applied Management, Economics and Finance – Belgrade, Serbia;
ISBN 978-86-80194-20-2, ISSN 2683-5568, DOI: https://doi.org/10.31410/ERAZ.2019
Abstract
The scope of this research is to provide a theoretical framework to the Variable Cost of
Capital. Current theory uses Static Capital Structure and Constant Cost of Capital for Firm Valuation.
This is being challenged and an improved approach to measure the Firm value on the basis of a Variable
Capital Structure and hence Variable Cost of Capital, is being proposed. When a firm changes its
Financial Leverage, it is expected that the Components of Cost of Capital will change. Cost of Equity
is known to have a linear relation with Financial Leverage). If the level of Debt in Capital Structure
varies, the cash flow available to the Debt holders as well as the Equity holders will change. The
risk-level borne by the Debt holder as well as the Equity holder will also change. Keeping this in mind,
the constancy assumption of the Cost of Debt is being challenged in the paper. The Weighted Average
Cost of Capital, useful for discounting firm cash flows, is being estimated as being Variable with time,
in the proposed paper. The existing and proposed Valuation Frameworks are being detailed below
and the variables in the current literature as well as the proposed concept are tabulated below. This
empirical investigation should be conducted with a set of sample firms. The results from the empirical
investigation should be divided into Valuation using Static WACC and Valuation using Dynamic WACC.
The difference in Value obtained using the two methodologies should be compared for statistical differences.
The idea of Dynamic WACC can be extended to the problem of Firm Valuation as well as Project
Valuation and Corporate finance practitioners can get a better sense of the risk level of the firm.
Key words
Variable WACC, Financial Leverage, Valuation.
References
[1] Parsons, C A. and Titman, S, Empirical Capital Structure: A Review (2008). Foundations
and Trends in Finance, Vol. 3, No. 1, pp. 1–93, 2008. Available at SSRN: https://ssrn.com/
abstract=2131759
[2] Damodaran, Aswath (2006) Damodaran on Valuation: Security Analysis for Investment
and Corporate Finance (Wiley Finance)
[3] Koller Tim, Goedhart Marc and Wessels, David (2008) Valuation, Measuring and Managing
the Value of Companies, Wiley, 4th edition
[4] Fernandez, Pablo, Company Valuation Methods (October 11, 2017). Available at SSRN:
https://ssrn.com/abstract=274973 or http://dx.doi.org/10.2139/ssrn.274973
[5] Jagannathan, Uday Kumar; Suresh, N. The Nature and Determinants of Capital Structure
in Indian Service Firms. Indian Journal of Finance, [S.l.], p. 30-43, Nov. 2017. ISSN
0973-8711. Available at: . Date accessed: 10 May. 2019. Doi:10.17010/ijf/2017/v11i11/119340.
[6] Modigliani, F., & Miller, M. H. (1958) The cost of capital, corporation finance and the
theory of investment, The American economic review, 261-297.
[7] Honková, I., (2012). Dynamic model WACC. In: Advances in Finance & Accounting: Proceedings
of the 1st WSEAS International Conference on Finance, Accounting and Auditing,
Zlín: Tomas Bata University, 268-274