Limitations / Issues With Weighted Average Cost of Capital (WACC)

To start with, Drury (2015) postulates that whereas it is easy to calculate relative debt and equity values, calculating the cost of debt and equity required to determine WACC has often been quite challenging. This view is in consonance with Atrill and Maclaney (2019) submission that in calculating the two values, different options are provided and each has its own shortcomings since there is at least one estimate. Consequently, the calculated value of debt and equity varies due to different estimates which in turn provide varying WACC.  Additionally, WACC applied to undertake new projects demand taking into account the present cost of capital and due to fluctuating interest cost of debt, knowing the cost of capital becomes problematic (Bodmer, 2014). Furthermore, while calculating WACC, equity, debt and preference shares are the only factors considered to make it simple to determine WACC. However, if other considerations are taken into account such as convertible preference shares, extendable bonds and others which also affect a firm’s profit, the calculations becomes very complex thereby increasing the chances of mistakes (Pandey, 2015). Further on, cost of trade credit and short-term financings are similarly not accounted for, and if they were considered WACC would definitely change.