I have a question that has been on my mind ever since I learned about DCF. I was taught that for the DCF to be valid WACC should be constant. As a physicist by training this assumption is strange to me. I understand that having fixed WACC makes your life simple, but shouldn't it be possible to have a changing WACC is the explicit forecast period? Would this work if I:

  • Relever the $beta$ every year and thus modify the cost of equity ($r_e$)
  • Model chnages in debt cost ($r_d$) as a function of capital structure (this is a challenge itself, if you want to model bankrupcy costs).
  • Make sure that that capital structure is stable outside the explicit forecasting period.

Thanks for the help

P.S. I know that there are other methods I could use for valuation like APV which are much easier and allow for changing capital structure.

P.S. 2 In order to keep the model simple, I am always assuming that debt is exogenous and issued at the end of the year (this way I avoid the ciruclarity with interest expense and some other items).


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