WEIGHTED AVERAGE OF COST OF CAPITAL - Accounts and Finance for Managers

The term cost of capital is nothing but the overall cost of capital which is to be computed to the tune of the proportion of the funds in the mixture; should computed only to the tune of assignment of weights. The weight average cost of capital has its own steps to follow during the process of computation.

  • Assigning the weights
  • Multiplying the weights with the specific cost of the fund
  • Dividing the total cost immediately after adding them together by the summation of weights
  • It is denominated by Ko

The weights are normally classified into two major classification viz

  • Marginal weights
  • Historical weights

Marginal weights: Assignment of weights to the specific cost by the proportion of the each fund to be raised to the total fund

Historical weights: The weights are assigned to the specific source of fund to the tune of the proportion of the fund in the existing capital structure. This type of historical weight is further classified into two different categories viz:

  • Book value weights and Market value weights.
  • Book value weights are assigned to the tune of book values to measure the proportion of each type of capital.

Market value weights are assigned to the tune of market value to measure the proportion of each type of capital.

Problem

WEIGHTED AVERAGE OF COST OF CAPITAL

A company has on its books the following amounts and specific cost of each type of capital. Determine the weighted average cost of capital using (a) Book value weights and (b) Market value weights.
The determination of the weighted average cost of capital using book value weights

WEIGHTED AVERAGE OF COST OF CAPITAL

WEIGHTED AVERAGE OF COST OF CAPITAL


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