Question

The capital structure weights used in computing the weighted average cost of capital are:

Group of answer choices

preferably based on the target capital structure of the firm

preferably computed using the book value of debt and the shareholder’s equity

constant over time

preferably based on the weights adopted by similar firms in the same industry

Answer 1

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Please note the solution

> Concept

• The weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is proportionately weighted.
• All sources of capital, including common stock, preferred stock, bonds, and any other long-term debt, are included in a WACC calculation.

> Solution

Weighted average cost of capital is calculated based on capital structure of the company.

Further, proportion of each source is calculated by taking market value or book value of the particular source of capital.

Thus in our case Option B is correct.

In option A target capital structure is taken whereas we need to calculate present WACC. Thus this option is incorrect.

In option C, weights adopted by similar industry is taken which is also not correct since it will not give truer picture about the company itself.

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