I thought MCC was the same as WACC…But i read today that if MCC is equal to WACC we have optimal capital structure.and if incremental opportunity schedule is equal to MCC we have optimal capital budget …what is the differnce?
WACC is average; MCC is marginal. Just like average total cost and marginal cost in Econ.
WACC is the average interest rate you pay if you borrow $10 million. MCC is the cost of borrowing $1 after you’ve already borrowed $10 million.
ok so they are not equal…but what about this thing about optimal capital budget and optimal capital structure.when MCC = WACC
Go back to the Econ analogy: where does the marginal cost curve cross the average total cost curve?
If MCC is less than WACC, what can you tell me about WACC (as you raise more capital)? If MCC is greater than WACC, what can you tell me about WACC (as you raise more capital)?
page 303 scheweser Reading #34 - Accounting Shenanigans on the Cash Flow Statement
One way to determine whether a firm is stretching its payables is to examine the number of days in accounts payable. Days’ sales in payables is calculated by dividing accounts payable by COGS and multiplying the result by the number of days in the period. days’ sales in accounts payable = account payable/COGS x number of days
Please chk for me
sorry mistake…i was commenting somewhere else
I haven’t started with Ecos yet; so, I can’t comment much on this.
It tells me that raising more capital is still viable because given the firm’s current risk, raising more capital is cheaper. I am assuming WACC corresponds to current risk that the firm has. On the other hand, if MCC>WACC, it is not viable to take more projects as it would be costlier w.r.t. the firm’s current capital structure. Unless, the project geberates a huge income for the firm which can offset the increased cost of capital, it isn’t viable to go for this project.
Quick question: So, how do we justify that when MCC corsses WACC, that is the point of optimal capital budget. What is the new project had a very high NPV, still it has a greater cost of capital. Why wouldn’t one go for it? Also, what is “optimal” in this case?
Let’s see what mokpokpo has to say before I comment further.
Sure.
(MCC is defined as the cost of the last dollar of new capital the firm raises, and the marginal cost rises as more and more capital is raised during a given period.(i know that)The WACC of the next dollar of capital raised in called is the marginal cost of capital (MCC).When the WACC is greater than MCC the firm should raise more capital.when the cost of raising additional capital is lower than the cost of capital then it makes sense to raise more capital.the reverse is also true.
In economics, firms should expand output to the point where marginal revenue is equal to marginal cost. At that point, the last unit of output exactly covers its cost—further expansion would reduce profits, while the firm would forgo profits at any lower production rate. Therefore, the firm should expand to the point where its marginal revenue equals its marginal cost.
Now the confusion:WACC are both Costs.How does this analogy apply.
I know we should define an investment opportunity schedule(constructed from expected returns),the a type of marginal revenue comes in.then MCC =IOS results in optimal capital budget.
Guys help me clear this!!!thanks
You need to reread what I wrote about the analogy:
Both costs: I didn’t mention marginal revenue.
i think i got it better now…the questions you guys raised made me think through it deeper.thanks
So . . . tell us. please.
WACC is the average cost; MCC is the cost of the next dollar. They’re not remotely the same thing. Reread the text; you’ve missed something.
WACC is average cost; ATC is average cost. MCC is marginal cost; MC is marginal cost. The analogy’s perfect.
My mistake: you’re correct.
@S2000magician: I had the same doubt after reading the text. Can you kindly explain on how they’ve used these terms interchangeably?