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Reply to the 2nd paragraph. APA. At least one reference.
Explain how the decision of the Federal Reserve Bank (Fed) to raise interest rates would be expected to affect each component of the weighted average cost of capital (WACC). What mistakes are commonly made when estimating the WACC, and how do these mistakes arise?
The Federal Reserve System is the central bank of the United States. It performs five general functions to promote the effective operation of the U.S. economy and, more generally, the public interest. The Federal Reserve has 3 entities and 5 Key functions (Federal reserve, 2017). The Fed attempts to align the effective federal funds rate with the targeted rate by making additions to or subtractions from the money supply through open market operations (Investopedia, 2018). They control long-term interest rates by targeting the federal funds rate, this is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank overnight. As interest rates are moderated, it can cause fluctuations in the risk-free rate, the theoretical rate of return for an investment that has no risk of financial loss. This can affect a firm's WACC because the risk-free rate is an important factor in calculating the cost of capital (Investopedia, 2018).
Structure of the Federal Reserve System retrieved from https://www.federalreserve.gov/aboutthefed/structure-federal-reserve-system.htm
Folger, J. (2014, September 2). How do interest rates affect the weighted average cost of capital (WACC) calculation? Retrieved from https://www.investopedia.com/ask/answers/070114/how-do-interest-rates-affect-weighted-average-cost-capital-wacc-calculation.asp
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Raise Interests rates and WACC
Hello, I agree with you on how the decision by the Federal Reserve Bank to raise interest
rates affects the components of the weighted average cost of capital. Nevertheless, I would like
to add more insights to this discussion by perhaps breaking down the effects of raising federal
interest rates to the particular c...
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