Question

The following information is for DEF, Inc. a national consumer products company:

Liabilities and Equity   Book values   Target Capital Structure
Notes Payable $200 3%
Long-term Debt 1,000 15%
Preferred Stock 500 5%
Common equity 4,200 77%

Assume that you are an analyst preparing to calculate DEF’s WACC and that the company’s target capital structure values above are unknown to you. Further, assume that DEF’s cost of debt and cost of equity values are significantly different from each other. How will your estimate of WACC be affected by using weights calculated from the known book values rather than the unknown target capital structure in your calculations?

Answer 1