Best way to estimate the "weights" in the calculation of WACC a)use book values for debt...

Best way to estimate the "weights" in the calculation of WACC

a)use book values for debt and equity

b)Use market values for debt and equity.

c)Non of the above

Expert Solution

The correct answer is b)Use market values for debt and equity.

WACC or the Weighted Average Cost of Capital uses the market value of debt and equity. Capital is the most essential item for any business. A business cannot function without capital. It has to procure capital from various sources such as from the shareholders by issuing shares of company or by taking loans and advances from banks or financial institution. There is a cost associated with such procurement. For example banks and financial instituitons charge interest against the loans and advances. This becomes the cost of debt. To get the debt from banks we need to pay interest to them. Similarly equity shareholders are paid dividend by the company for the investment in shares made by them.

The Weighted Average Cost of Capital or the cost of capital is calculated using the formula

Cost of Equity * Weight allocated to equity + Cost of debt * Weight allocated to debt* (1-Tax rate)

These weights are based on the market values.

jeff jeffy answered 1 year ago

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