DYNAMIC WACC: RE-ENRICHMENT OF DISCOUNTED CASH FLOW VALUATION TECHNIQUE

Abstract

The current and widely used traditional Discounted Cash Flows (“DCF”) valuation technique implements constant Weighted Average Cost of Capital (“WACC”) as discount factor in estimating the company’s value. However, previous studies in firms’ financing behavior have shown that the implementation of constant WACC is not applicable to real finance practice. Moreover, the recent studies in finance have highlighted the importance of internal financing towards the financing behavior and WACC of the company. In this study, the researcher would like to introduce new DCF valuation technique which implements the dynamic WACC rather than the constant one by emphasizing on the impact of a firm’s internal financing capability in accordance to Pecking Order Theory. Based on the Root Mean Square Error (“RMSE”) and Standard Error (“SE”) indicated by the statistical analysis from eight public-listed non-financing companies from various industry sectors in Indonesia Stock Exchange, the implementation of the dynamic WACC has better accuracy in estimating the company’s value as indicated by the share price, aligned with the Pecking Order Theory. Future research should develop and enrich the currently implemented traditional DCF valuation technique from other dimensions, such as the Free Cash Flows and the Terminal Value.