Question

1. Explain why we use market values in determining a company's capital structure for capital budgeting.
2. I always tell my students that the hardest part of capital budgeting is estimating future cash flows, why is that?

Thanks

Answer 1

1)We have to use market value of debt and equity than the book value while computing WACC since because of change in interest rates and other factors the debt value will change along with the market value of the equity. If interest rate increases the value of debt comes down and this is not shown in book value but we can capture in market value

2) In estimating future cash flow we take lot of assumptions like sales forecast, pricing, cost estimation which may change because of change in external factors which are not in company’s control.