Question

In order to calculate an entity weighted average cost of capital (WACC) financial weight have to be set each component in the firms capital structure. the weight may be calculated as book or market value and as historic or target figures.

Explain what is meant by these four types of weights.

Answer 1

1.Book Value WACC:Book value WACC is calculated using book value weight.It is the weighted average of cost of each component of capital where the weights are used from books of accounts to determine the overall weighted average cost of capital.It is a highly traditional method where the focus is over the accounting record

2.Market value WACC:Market value is calculated using sources of market value capital.It is determined using the current market price of the equity portion to evaluate and it also looks for market value of debt to arrive at the weighted average cost of capital. It is calculated by considering the Market value of Company which is Estimated by Market value of Debt and Market value of equity put together.It also accounts for Market value of cost of debt as well as equity and it is more sophesticated than Book Value.

3.Historical weight:It supports the longer view and the conservative approch which advocates for the going concern concept of the firm. This is the portion of actual existing capital structure in terms of market value or book value.It assume that the firm will finance its future projects in the existing capital structure .

4.Target WACC- This Method of calculation of WACC Should be done after using Target Capital Structure. It is the capital structure the company intends to use in the long run.It is Highly focused at using a safer approach to WACC which accounts for a larger portion of debt and it is more of short term than Historical WACC method. These weights could be either in accordance with Market value or book value.