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#cfa-level-1 #corporate-finance #reading-36-cost-of-capital

Suppose we are using the company’s current capital structure as a proxy for the target capital structure. In this case, we use the market value of the different capital sources in the calculation of these proportions. For example, if a company has the following market values for its capital

Bonds outstanding$5 million
Preferred stock1 million
Common stock14 million
Total capital$20 million

the weights that we apply would be

wd =0.25
wp =0.05
we =0.70

Example 3 illustrates the estimation of weights. Note that a simple way of transforming a debt-to-equity ratio D/E into a weight—that is, D/(D + E)—is to divide D/E by 1 + D/E.

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2.2. Weights of the Weighted Average
od 1 as the baseline. Note that in applying Method 3, we use an unweighted, arithmetic average, as is often done for simplicity. An alternative is to calculate a weighted average, which would give more weight to larger companies. <span>Suppose we are using the company’s current capital structure as a proxy for the target capital structure. In this case, we use the market value of the different capital sources in the calculation of these proportions. For example, if a company has the following market values for its capital Bonds outstanding $5 million Preferred stock 1 million Common stock 14 million Total capital $20 million the weights that we apply would be w d = 0.25 w p = 0.05 w e = 0.70 Example 3 illustrates the estimation of weights. Note that a simple way of transforming a debt-to-equity ratio D/E into a weight—that is, D/(D + E)—is to divide D/E by 1 + D/E. <span><body><html>


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