WACCBook

weights and market weightsWebster Company has compiled the information shown in the following table:

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.a.Calculate the weighted average cost of capital using book value

weights.

b.Calculate the weighted average cost of capital using market value

weights.

c.Compare the answers obtained in parts a and

b.

Explain the differences.

Question content area bottom

Part 1

a.The firm's weighted average cost of capital using book value weights is

enter your response here%.

(Round to two decimal places.)

Part 2

b.The firm's weighted average cost of capital using market value weights is

enter your response here%.

(Round to two decimal places.)

Part 3

c.Compare the answers obtained in parts a and

b.

Explain the differences. (Select the best answer below.)

A.

The book value approach yields a lower cost of capital because the costs of the components of the capital structure are calculated using the prevailing market prices. Since the common stock is selling at a higher value than its marketvalue, the cost of capital is much higher when using the book value weights.

B.

The market value approach yields a lower cost of capital because the costs of the components of the capital structure are calculated using the prevailing market prices. Since the common stock is selling at a lower value than its bookvalue, the cost of capital is much lower when using the market value weights.

C.

The book value approach yields a higher cost of capital because the costs of the components of the capital structure are calculated using the prevailing market prices. Since the common stock is selling at a lower value than its marketvalue, the cost of capital is much higher when using the book value weights.

D.

The market value approach yields a higher cost of capital because the costs of the components of the capital structure are calculated using the prevailing market prices. Since the common stock is selling at a higher value than its bookvalue, the cost of capital is much higher when using the market value weights.

Long-term debt $4,000,000 $4,120,000 0.08% Preferred stock $40,000 $59,000 0.13% Common stock equity $1,060,000 $4,431,000 0.17% Totals $5,100,000 $8,610,000