Question

Which of the following statements is correct? The weighted average cost of capital is calculated on a before-tax basis. An increase in the market risk premium is likely to increase the weighted average cost of capital. The weights of debt and equity should be based on the balance sheet because this is the most accurate assessment of the valuation. All of these statements are correct.

Answer 1

Correct Statement is - "An increase in the market risk premium is likely to increase the weighted average cost of capital"

WACC is always calculated on apost-tax basis and normally has 2 or 3 components weighted by their market values (and not book values) - debt, preferred stock and common stock.

Cost of Equity is determined by CAPM method. where

Cost of Equity = Risk Free Rate + Beta * Market Risk Premium => Increase in market risk premium would increase the cost of equity, since they are directly rleated.