What happens to enterprise value (EV) when the weighted average cost of capital (WACC) increases, given mostly negative cash flows?

When the weighted average cost of capital (WACC) increases, it has a specific impact on the present value (PV) of future cash flows, particularly when those cash flows are mostly negative. An increase in WACC signifies that the risk associated with the investment has risen, which leads to a higher discount rate applied to future cash flows.

In the context of negative cash flows, this increased discount rate further diminishes the present value of those cash flows when calculated for valuation purposes. Essentially, the higher WACC amplifies the effect of negative cash flows by reducing their present value significantly, which means that the overall enterprise value would decrease.

This understanding is based on the principle that higher discount rates lower the present value of future cash flows. Therefore, the choice that states the increase in WACC reduces the effect of negative cash flows on present value accurately reflects how the valuation is impacted by rising costs of capital amidst negative cash flow positions. The present value of negative cash flows will become less significant due to the higher discounting effect caused by a greater WACC.