1. Why market value rather than book value in WACC give example? Why do we use m
ID: 1174749 • Letter: 1
Question
1. Why market value rather than book value in WACC give example? Why do we use market value? 2. What is relationship between WACC and capital structure? 3. What is reasons for working capital? Why do we need working capital? Give example Thank you1. Why market value rather than book value in WACC give example? Why do we use market value? 2. What is relationship between WACC and capital structure? 3. What is reasons for working capital? Why do we need working capital? Give example Thank you
2. What is relationship between WACC and capital structure? 3. What is reasons for working capital? Why do we need working capital? Give example Thank you
Explanation / Answer
1. Book value weights are readily available from balance sheet and are simple to calculate, where as market value have to be determined and it is a difficult task to acquire accurate data especially when equity of entity is no listed....Still market value is considered appropriate by analysts because an investor would demand market required rate of return on market value of capital and not on book value of capital.. Moreover using book value is against princple of share holders wealth maximization
EXAMPLE: Assume a firm issued capital at $10 per share 5 years back..current market value of share is $30 and book value is $18, market required rate of return is 20%...Investors(new or existing) expect a return on $30 and not on $18..
2. Cost of capital is important in determing companies capital structure. Companies are usually looking for the optimal combination of debt and equoty to minimize the cost of capital. Optimal cost of capital is estimated by calculating the mix of debt and equity that minimize the wacc while maximizing its market value.. The lower the cost of capital the greater the present value of firms future cash flows discounted by wacc. Capital structure and cost of capital have direct relationship in terms of financial well being of company..
3. Working capital is the fund available to your company for use in your day to day operations, without workimg capital you wouldnt be able to stay in business... Working capital is also what investors will look to assess both your companies short term financial wealth and its liquidity..
Working capital is good indicator of how your companies inventory, account receivables, payables, and cash in hand are managed..if these are smartly handled and your business is healthy, this will reflect in your working capital. An effective working capital managment system helps business not only cover their financial obligation but also boost their earnings..
EXAMPLE: If a manufacturer that has current liabilities of $100000 and current assets $200000 has working capital $100000 this means that after all the current liabilities are paid off the company still has 100000 of current assests remaining . This manufacturer is highly liquid. When analyzing a companies working capital it is important to look at its total working capital as well as its current ratio...
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