Cost of Debt

An important part of economic value involves the consideration of the risks associated with
corporate decision-making targeting the creation of value. In this sense, going too far is just as
bad as coming up short.
Where are the risks in our valuation model that uses cash flows discounted at WACC?
In FCFs, one must consider the main operating risks inherent to the different business policies
of the company involving sales, personnel, logistics, production, overheads, collection,
investment, etc. Once these risks have been identified and their importance quantified, they are
normally included in the valuation model through sensitivity analyses or probability simulations.
WACC includes financial risk stemming from the gearing ratio implied by the capital structure;
risks perceived by shareholders, which form part of the cost of equity (market-risk premium and
systematic operating and financial risks of the company); and risks perceived by financial
entities that are included in the cost of debt.
Table 7 summarizes these risks.
Table 7
ECONOMIC
VALUE

COMPONENTS

IN FCF
OPERATING FCF
FCF FROM WORKING CAPITAL
FCF FROM INVESTMENT IN FIXED
ASSETS
IN WACC

ASSOCIATED RISKS

OPERATING RISKS:
IN OPERATING ACCOUNT COMPONENTS
IN WORKING CAPITAL COMPONENTS
IN INVESTMENT COMPONENTS

COST OF DEBT

RISKS PERCEIVED BY FINANCIAL ENTITIES

COST OF EQUITY:
EQUITY BETA

SYSTEMATIC OPERATING AND FINANCIAL RISKS
PERCEIVED BY SHAREHOLDERS

CAPITAL STRUCTURE

FINANCIAL RISKS

There is a high probability of duplicating or omitting relevant risks when said risks are not
adequately identified and their correct inclusion in the model is not verified.