ACA Financial Management Practice Exam

The correct choice identifies that the debt and equity ratio is subject to change, which is not an assumption of the Weighted Average Cost of Capital (WACC).

WACC is based on specific static assumptions regarding risk, return expectations, and the overall cost of financing. One of the key assumptions is that the systematic business risk remains constant. This means that the risk that investors perceive in the business does not fluctuate with changes in capital structure over the short term. If the risk were to change significantly, it could alter the required rate of return on equity and debt, thus impacting the WACC.

Additionally, WACC assumes that financing is not project specific, meaning the cost of capital is viewed as an average across all projects and is not adjusted for specific project risk. This suggests that the WACC remains relatively stable across different projects unless the overall business risk changes substantially.

Moreover, the assumption that equity investor expectations remain stable implies that the returns investors expect from equity will not fluctuate wildly, allowing for a consistent approach in calculating WACC.

In summary, the concept of WACC is constructed on the premise that certain key variables remain constant, and the inclusion of a changing debt and equity ratio contradicts these foundational assumptions, thus making it the correct identification of what is