Question

ABC Trucking's balance sheet shows a total of noncallable $38 million long-term debt with a coupon rate of 5.60% and a yield to maturity of 8.80%. This debt currently has a market value of $55 million. The balance sheet also shows that the company has 12 million shares of common stock, and the book value of the common equity is $216.20 million. The current stock price is $20.10 per share; stockholders' required return, rs, is 14.15%; and the firm's tax rate is 37.00%. The CFO thinks the WACC should be based on market value weights, but the president thinks book weights are more appropriate. What is the difference between the WACCs using market value and the book value?

Answer 1

Weighted Average Cost of Capital using Market Value Weights is calculated using market value sources of capital. And Weighted Average Cost of Capital using Book Value of sources of capital.

Market Value WACC is considered appropriate because an investor would demand market required rate of return on the market value of the capital and not the book value of the capital.

Because by taking above example, While calculating cost of equity the book value rate will be different for weighted average cost of capital. WACC using Market value will be higher than WACC using Book Value Rates..