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Weighted Average Cost of Capital using Book value and Market Value

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1. Promo Pak has compiled the following financial data:

(a) Calculate the weighted average cost of capital using book value weights.
(b) Calculate the weighted average cost of capital using market value weights.

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Solution Summary

This solution helps to find out book value WACC and Market value WACC.

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Weighted Average Cost of Capital

Please assist with the following statements and question:

There are few ways to compute the weighted average cost of capital for a company: Of course one first estimates the 'cost' (in percentage terms) of the three main sources of capital: short term debt or liabilities, long term debt or liabilities and the cost of equity, and then computes the WACC using 'appropriate weights' as follows:

(1) Use the balance sheet of 'book values' of the different sources of capital as the 'weights'.

(2) Use the market value of short term debt (or liabilities), long term debt (or liabilities) and the market value of equity as 'weights'

(3) Use the "Target Capital Structure" of the company as the 'weights'.

Which of the three approaches should be adopted? Why?

Thanks in advance for your time and assistance!

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