Question

Which of the following statements is NOT correct?

a. When estimating the cost of debt, don’t use the coupon rate on existing debt.

b.Use the current interest rate on new debt. When estimating the risk premium for the CAPM approach, don’t subtract the current long-term T-bond rate from the historical average return on common stocks.

c. Use the target capital structure to determine the weights. If you don’t know the target weights, then use the current book value of equity in the balance sheet, and never use the market value of equity.

d. Capital components are sources of funding that come from investors. Accounts payable, accruals, and deferred taxes are not sources of funding that come from investors, so they are not included in the calculation of the WACC.

Answer 1

It is not about determination of the target weight of equity by use of value of the equity in the balance sheet, the market value of equity should be used at other than the book value of equity because that would be representing the true valuation of the company so weighted average cost of capital is more focused at determination of weights of a company using a market, rather than book value.

All the other statements are representing the true statements so they are not the correct answer.

Correct answer would be option (C).