The Cost of Capital

[@davidsaomi6493]

Hi Michael! For the choice of using the market cap as the weight for equity, is there an underlying assumption that markets are efficient and that the stocks investors act rationally? If that's the case, would the market weight theoretically be an estimate of the "true" value of equity?

[@MichaelWardFinance]

The accounting (or "book") value of equity is little more than an historical artefact of accounting (to ensure the balance sheet "balances"). It is often a small percentage (eg 50%) of the market cap of the company, and so it makes no sense to use the book value of equity as the weight for equity when calculating WACC. SO, yes, we are assuming that markets are operationally efficient and that investors are rational. To improve the measure, we might take the average market cap over the last (say) 3 years, and not a point estimate.