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Disadvantages of Weighted Average Cost of Capital (WACC) The disadvantages are stemmed mainly from the assumptions of the applicability of WACC. The practicability and limitations of the assumptions are discussed below. The remedy to overcome the problem is also specified. Difficulty in Maintaining the Capital Structure: The impractical assumptions of ‘No Change in Capital Structure’ has rare possibilities of prevailing all the time. It suggests same capital structure for new projects. There are two possibilities for funding the project in this way. First is to fund it with the retained earnings. In this case, it would be reasonably correct to assume that the new project is funded with same capital structure. The limitation here is of availability of free cash with the company. Even if the free cash is available, it will put a cap on the size of the investment. Suppose, the new project requires, $100 million, the company has only $70 million. What to do for the remaining $30 million? 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Let us assume two situations: Company Expanding in its Own Industry: The assumption can be reasonably true if the company is expanding in its very own industry and the same business like the textile example given above. Still it is not completely true because the risk associated with installing looms in past and today may be different. The technology may be different and complicated. The quality and cost aspects may be dissimilar. Company Expanding in Different Industry: The assumption in this case would surely prove malicious. It is because FMCG and Heavy Machineries cannot have same risk profile. Having different risk profile, the cost of equity would also be different and therefore applying the same WACC pose a very high risk of rejecting good projects that will create value and accepting projects that will diminish the value of the shareholders wealth. Remedy to this problem is that the WACC should be adjusted to take effect of the change in risk. 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There are other theories like Adjusted WACC and Adjusted Present Value Approach to circumvent the disadvantages of WACC.

narahari · Answer 53 · 2015-11-30 09:04:38 UTC

• Since, the receipts are much less frequent than issues; the method is not so cumbersome because calculation of new prices arises only when fresh lots are purchased. • This method evens out the effect of widely varying prices of different consignments. Disadvantages • Issues may not be at the current economic values.

lochan · Answer 54 · 2015-09-14 18:26:05 UTC

lochan answered over 7 years ago

**ADVANTAGES OF WEIGHTED AVERAGE METHOD** Advantages • Since, the receipts are much less frequent than issues; the method is not so cumbersome because calculation of new prices arises only when fresh lots are purchased. • This method evens out the effect of widely varying prices of different consignments. Disadvantages • Issues may not be at the current economic values. • Where receipts are numerous this method requires a good deal of calculations. • Profit or loss may arise out of pricing. • Issue price may run to a number of decimal points. Thanks

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Advantages and disadvantages of weighted average method

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Advantages and disadvantages of weighted average method

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