An Analytical Process for Generating the WACC Curve and Locating the Optimal Capital Structure

This work leans more towards the analytical side, focusing on providing a detailed discussion and derivation of the process that leads to the above-mentioned curves. Before going any further, it would be helpful to touch on some of the relevant works and their relation to our objectives. There are at least two issues that surround the WACC and/or the WACC curve. Firstly, how accurately can the WACC be calculated? And, secondly, if it were at all possible to obtain the WACC accurately, would it ever serve as a useful metric to appraise a company’s performance? These two issues are covered well in the literature, but since we are interested only in the first, we shall ignore the second, as it has no relevance to our objectives here.1 As far as we are aware, there is one conventional technique for obtaining the WACC curve. The method revolves heavily around the M&M principles, and makes use of the CAPM-based cost of [or return on] equity2, the cost of debt, the tax rate and values of debt and equity. Although practical and theoretical courses3 abound on how to apply the technique, and its variants, to obtain the curves of interest, the literature, in large, appears to lack any thorough description, detailing the actual procedure itself. We intend here to fill in the gap by providing an