On WACC specifications and capital structure decisions: some conceptual propositions for practicing managers

Abstract

Recent advances in our understanding of capital structure decisions have not yet made their mark upon our capital budgeting techniques and practices. This paper attempts to bridge this gap. In doing this, it offers a surprisingly simple approach for managers to follow in marking financial decisions. The theory of corporate finance notes two alternative specifications of the weighted average cost of capital for discounting. In one, the cost of debt is specified in pre-tax terms while the tax shield on debt is accounted for in the cast flows. In another, the cost of debt is specified in after tax terms while the tax shield on interest is ignored in the cash flows. Theoretically the two alternative specifications of WACC and cash flows are considered equivalent.