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CA Intermediate · Financial Management and Strategic Management · Cost of Capital

Which of the following is the most appropriate weight to use when calculating the Weighted Average Cost of Capital (WACC) for evaluating a firm's future projects?

The target or marginal capital structure weights are the most appropriate, because WACC for future projects should reflect the mix of funds the firm plans to raise going forward, not the proportions of past financing recorded at book values or historical issue amounts.

  1. ABook value weights of existing capital
  2. BHistorical weights based on the capital raised at the time of issue
  3. CTarget (marginal) capital structure weights the firm intends to maintainCorrect
  4. DWeights based only on the cheapest source of finance

Explanation

For future financing and investment decisions, WACC should reflect the proportions in which the firm intends to raise funds, i.e. the target or marginal capital structure. Book value and historical weights reflect past financing and may not match future plans. Using only the cheapest source ignores the mix of funds actually used.

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