Question

The proportions of debt and equity used in calculating the weighted average cost of capital (WACC) should be ‘ideally’ based on the current _______ weights of the individual components. A)book value B)market value C)target value

Answer 1

Correct option is B) market value

The proportions of debt and equity used in calculating the weighted average cost of capital (WACC) should be ‘ideally’ based on the current market value weights of the individual components.

Reason: As we calculate cost of debt and equity based on current market rates therefore, it implies that the weights should also be applied which are based on market value.

The book based WACC will result in wrong decision making because the cost of equity and cost of debt is not static for any firm. Book value remains static and could result in wrong decision making.