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should market weight or book weights be used in determining the cost of capital?

should market weight or book weights be used in determining the cost of capital?

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Answer #1

Market weight should be used in determining the cost of capital of the firm.

Cost of capital is nothing but Weighted average cost of capital (WACC). The market value of each component like, debt equity and preference should be used to determine appropriate weight of each components.

Book value of the components mentioned above stays at historical cost and they don’t give right overview on the cost of capital because current cost of capital is based on market values of the capital component which firm holds and cost of capital determined by using market weights will throw right discount rates.

Formula:

WACC = Cost of equity x Weight of equity + Cost of preferred share x Weight of preferred share + Cost of debt x Weight of debt x (1-Tax rate)

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