Weighted Average Cost of Capital (WACC)
What weights should we use when calculating WACC?
When calculating Weighted Average Cost of Capital (WACC), weights used should typically be based on:
O Market (aka volatile) value weights
O Book (aka historical) value weights
O Market (aka volatile) value weights
O Target (aka optimal) weights
Answer
The correct option is 'Market (aka volatile) value weights.' Market value weights consider the proportion of a company's total market value that each source of capital (equity, debt, etc.) represents. This approach reflects the current valuation of the company and provides a more accurate representation of the capital structure and the costs associated with each component.
Market value weights are considered ideal for calculating WACC because they take into account the current market conditions and provide a more realistic view of a company's capital structure. Using book value weights based on historical accounting values may not accurately represent the true economic value of the company due to market fluctuations.
Target weights, also known as optimal weights, are used to represent the desired capital structure of a company but are not typically used in WACC calculations. Market value weights are preferred as they provide a more accurate reflection of the company's financial standing.
In conclusion, when calculating Weighted Average Cost of Capital (WACC), it is important to use market value weights to get a true representation of the company's capital structure and the costs associated with each component.