CFA Practice Question

There are 233 practice questions for this study session.

CFA Practice Question

Which of the following statements is false?
A. To calculate the weighted average of capital, a firm uses the target proportions of debt, preferred stock, and common equity.
B. To calculate the weighted average of capital, a firm uses the actual proportions of debt, preferred stock, and common equity.
C. The weights used to calculate the WACC should be based on the market values of debt and equity.
Explanation: The target amounts are used, since this reflects where the firm wants to be and what the weights should be over the long run. The actual weights contain short-term deviations from the firm's goal.

User Contributed Comments 7

User Comment
andrewsutton Doesn't this result in the firm rejecting potentially profitable projects (if the firm's capital is cheaper than 'target'), or approving lossmaking projects (if the reverse). What is the advantage of that?
george2006 C: The weights should be market value of those components.
ehc0791 The target weights should always be used.
fengting according to the textbook, target weights should be used. If they're not available, we should then consider market values.
proudpinay @andrewsutton: I think that's the limitation of this. I think the WACC is good for benchmarking the potential investment. If the potential investment is below the cost of capital, then the company might just distribute the available retained earnings to its shareholder. Or if the cost of debt is more than the estimated profit on this investment, better to forgo this opportunity.
CFA1Dec11 So what is the final answer of this one ? I had marked Target Prices ...
amemorera Wouldn't C be false, since we first use the target and then the market value of the actual structure?
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