Do you use market value or par value if both are provided? I assume that if “target” is provided you always use that?
I would use market value. Because if you go to sell the company, that is what you are going to get.
market value if provided, BV if no other option
what if target and BV are provided? what if target and MV are provided?
Market Value, always. If MV is not provided then BV.
Sorry didn’t see target in your question first. I would say (in order of preference): 1. Target 2. Market value 3. Book value
Below is the question that is giving me confusion. It says that target should be used over MV. But Schweser book 3 page 52 says that the weights are market values (and part of the answer explanation below even says that you should use market values). So does the equation simply assume that MV = target and if there is a difference use target? Marina Syltus, chief financial officer of Worcester Water Treatment, wants to know the cost of the company’s capital so it can make wiser budgeting decisions. Syltus has assembled the following data: Worcester’s long-term debt has a market value of $230 million. Worcester’s shares have a total market value of $782 million. The marginal tax rate is 37%. The required return on equity is 14.6%. Worcester’s long-term debt has a weighted average interest rate of 9.4%. To calculate the weighted average cost of capital, Syltus needs: A) both the required return on debt and the target debt/equity ratio. B) the required return on debt. C) the target debt/equity ratio. The correct answer was A. The equation for the weighted average cost of capital is as follows: Market value of debt / market value of debt and equity × required return on debt × (1 − tax rate) + market value of equity / market value of debt and equity × required return on equity. As such, we need the required return on debt to determine the WACC. However, analysts normally assume debt and equity are at their target ratio to calculate the cost of capital. If the current capital allocation does not match the target weighting, we use the target weighting. Thus, we also need the target weights for debt and equity, which we can derive from a target debt/equity ratio.
The question only gives market values, nothing else. If that’s the case, you can’t do anything else but assume that target = market … right? If the question had given both market and target, then I’d definitely use the target weights.
I think I’ve answered my own question…I should have read on in Schweser before posting. On page 53 it says “We typically assume that the market value weights of debt and equity are equal to their target weights. When this is not the case, the WACC calculation shuld use the target weights for debt and equity.” SO the rationale of the question is that target typically equal market value but since we do not know for sure we should request the target weights (since a difference would mean you use the target). Poor quality question I think but at least I see the rationale now.
idreesz Wrote: ------------------------------------------------------- > Sorry didn’t see target in your question first. > > I would say (in order of preference): > > 1. Target > 2. Market value > 3. Book value +1