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Question 9.S-TQ4: Should companies use their current weighted average cost of ...

Should companies use their current weighted average cost of capital as the discount rate when assessing the acceptability of new projects?

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There are certain conditions that must be met in order for it to be appropriate to use a historical WACC to appraise new projects, as follows:

– The new project must have a similar level of business risk to the average business risk of a company’s existing projects.

– The amount of finance needed for the new project must be small relative to the amount of finance already raised.

– The company must be intending to finance the new project by using a similar financing mix to its historical financing mix.

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