Posts Tagged ‘WACC’
Too much cash increase WACC, reduce company value. why do software companies like SAP have so much cash on b/s
Question by Jeanie: Too much cash increase WACC, reduce company value. why do software companies like SAP have so much cash on b/s
I am trying to understand why SAP, Microsoft and other software companies sit on a pile of cash.
Answer by Mike A
Too much cash will more than likely decrease WACC because it increases the quick/current ratio thus making the firm more able to make its short-term debt payments (primary factor in firm solvency). This decreases the cost of debt capital and reduces WACC as a whole.
In general, firms create value for the shareholder by undertaking positive NPV projects. Since the cash flows are discounted by the WACC (assuming the project is as risky as the firm), it opens up more options for the company if they have a lower cost of capital hurdle rate. In addition, it enables a company to accept a negative NPV project without endangering the future of the company. They would do this for the sake of obtaining a strategic advantage in a market or for a real option on another project in the future. The best example I can think of for this is the Xbox. The platform itself is a negative NPV project (and would be an even lower NPV if MSFT couldn’t discount it at a lower WACC because of the cash it uses to back the system). But through licensing fees, the introduction of the Xbox360, Xbox live subscription services, and any other yet to be exposed real options, the project has arguably increased the value of the firm.
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