As you study to take the CTP exam, a good portion of your time is
devoted to preparing to answer a fairly large number of calculations.
In fact, 10%-15% of the exam questions require the use of higher math
skills to “crunch the numbers”. However, it’s possible that you could
be asked a conceptual question about a given calculation rather than
being asked to just do the calculation. A good example of this
situation is the Weighted Average Cost of Capital (WACC) calculation.
Over the last couple of years a number of CTP candidates who have
taken the exam have told me that they got a conceptual rather than a
computational question about the WACC. And while they were comfortable
with how to “crunch the numbers”, they were not prepared to answer a
question where they were asked how a change in one of the variables like
the Marginal Tax Rate, for example, would impact a company’s WACC. So,
here are a couple of guidelines that can be used to answer conceptual
questions about calculations that you can apply to the WACC specifically
or to other calculations generally.
1) The WACC varies PROPORTIONALLY with changes in the following:
- Borrowing Rate: If the borrowing rate for new financing
changes due to rising or falling interest rates, the WACC will increase
or decrease respectively.
- Cost of Equity: If this variable increases or decreases due to a
re-evaluation of its cost, the WACC will increase or decrease
2) The WACC varies INVERSELY with changes in the Marginal Tax Rate(MTR):
- If MTR increases then the WACC decreases.
- If MTR decreases then the WACC increases.
To apply these guidelines generally when you are studying a
calculation just ask yourself which of the variables impact the answer
proportionally and which impact the answer inversely.
Using this technique to study the calculations can help you to; 1)
better understand how to solve a given calculation or 2) prepare you to
answer a conceptual question regarding the calculation.
-George Schilling, CTP