ExpertMinds LogoExpertMinds
Medium2 marksMultiple Choice
Estimating the Cost of CapitalSection ACost of CapitalWACC

ACCA · Question 09 · Estimating the Cost of Capital

Section A

MediScan Diagnostics is calculating its Weighted Average Cost of Capital (WACC) to appraise a new MRI facility. The finance director is debating whether to use book values or market values for the weighting of equity and debt.

According to financial management theory, which of the following statements regarding WACC weightings is correct?

Answer options:

A.

Book values should be used because they are objective and not subject to daily stock market fluctuations.

B.

Market values should be used because they represent the current opportunity cost of capital to the investors.

C.

Target book values should be used if the company plans to change its capital structure in the future.

D.

It makes no difference whether book values or market values are used, provided the calculation is mathematically consistent.

How to approach this question

Recall the theoretical basis of the WACC. It represents the rate of return currently demanded by providers of capital, so the weightings must reflect current market realities, not historical accounting figures.

Full Answer

B.Market values should be used because they represent the current opportunity cost of capital to the investors.✓ Correct
Financial management theory dictates that market values should be used to weight the components of WACC. This is because market values reflect the current opportunity cost of capital and the current economic value of the firm's securities, whereas book values are historical and often bear little relation to current reality.

Common mistakes

Choosing book values because they are 'stable' or 'audited'. While true, stability does not override the need for economic relevance in investment appraisal.
08All questions10

Practice the full ACCA FM — Financial Management Practice Exam 5

32 questions · hints · full answers · grading

Sign up freeTake the exam

More questions from this exam

Q01**Section A** The Global Clean Water Initiative is a non-governmental organization (NGO) focused...EasyQ02**Section A** NeuroTech Prosthetics, a high-growth medical technology startup, is seeking additi...MediumQ03**Section A** AeroCater Services provides specialized inflight meals to commercial airlines. The...MediumQ04**Section A** AgriNutrient Co requires 50,000 tonnes of raw phosphate annually for its fertilize...EasyQ05**Section A** SolarGrid Municipal is evaluating a new solar farm project. At a discount rate of ...Medium
View all 32 questions →