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THE WEIGHTED AVERAGE COST OF CAPITAL: SOME QUESTIONS ON ITS DEFINITION, INTERPRETATION, AND USE: COMMENT *
Author(s) -
McConnell John J.,
Sandberg Carl M.
Publication year - 1975
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1975.tb01860.x
Subject(s) - interpretation (philosophy) , capital (architecture) , economics , positive economics , epistemology , computer science , econometrics , mathematical economics , actuarial science , philosophy , history , archaeology , programming language
maximization of the total market value of the firm. The primary purpose of this comment is to reconcile the generally accepted definition of the after-tax weighted average cost of capital (wacc) with the definition proposed by Arditti. In accomplishing this objective we will derive three definitions of the wacc, and will show that the capital structure that minimizes two of the three definitions (within Arditti's framework) is an optimal one. The traditional wacc is derived from the relationship between the market value of a levered firm, VL, and its unlevered counterpart, Vu, both of which are expected to earn the perpetual cash flow X before interest and taxes.' Specifically,