Summary
The financial world is changing and undergoing metamorphosis. Companies like GM and Chrysler are insolvent. Stock indices gyrate for no reason. Financial giants regularly go bust these days - so it seems. In this scenario what we have is a situation where the basic formulae for computing the cost of capital and such basics as beta and delta are becoming misleading. It is just not possible to calculate the systematic risk attached to a market or the unsystematic risk of a security. In this analysis I look at where this confusion is heading and how we may soon see a sea change in the way in which financial costs based on accounting statements are calculated.
Analysis
1. The weighted average cost of capital (WACC) has for long dictated how financial managers and investors to a large extent decide the basis of calculation of financial decisions.
2. The present global situation presents a situation where the risk free rate of capital is going negative. If one looks at the changes in the price of gold - long considered the enduring store of value - then the risk free treasury bond is definitely not risk free anymore.
3. The markets today present a confusing situation and the economic situation is far from encouraging.
4. The referred article speaks mainly in reference to goodwill, short term WACC and long term WACC. It also speaks of confusion in the manner in which WACC is to be calculated and its purpose.
5. The basics of financial management I expect are in for a sea change in this situation. I would expect some new form of ratios and indicators to emerge soon in the present situation.
6. For the moment I would say don't rely on traditional indicators. It would probably be better to evaluate beta and delta in different situations for a given security. How - this is really left to the ingenuity of the decision maker - but this is how I think rational judgments can be made in the emerging financial and market situation.
