1.What would the major difference between ROI and WACC be?
2.What happens when folks use WACC for new items for budgeting purposes and then the price increases or the interest rate changes?
3.What you have to recalculate everything or just explain the differences?
1. The major difference between ROI (Return on Investment) and WACC (Weighted Average Cost of Capital) lies in their respective uses and calculations. ROI measures the return generated on an investment relative to its cost. It is calculated by dividing the net profit from an investment by its initial cost and expressing it as a percentage. On the other hand, WACC is the average rate of return a company needs to generate from all sources of capital to maintain its value. It takes into account the cost of debt, cost of equity, and the respective weights of these sources in the company's capital structure.
2. When people use WACC for budgeting purposes and the price of an item increases or the interest rate changes, it can have several implications. Firstly, if the price increases, it will impact the cost of equity and return expectations. This means that the company might need to adjust its WACC accordingly to reflect the new cost of capital and the higher return needed to justify the investment. Similarly, if the interest rate changes, it will affect the cost of debt, thereby impacting the WACC calculation.
3. When there are changes in price or interest rates, it is important to recalculate the WACC to reflect the revised cost of capital and return expectations. By recalculating the WACC, an organization can ensure that budgeting decisions are based on the most up-to-date and accurate information. Additionally, it is important to clearly explain the differences to stakeholders and decision-makers, highlighting the factors that have changed and the impact these changes have on the budgeting process. This will help them understand the adjustments made and the rationale behind them.