Series 79 practice questionhardWACC in DCF Valuation
An analyst is performing a DCF valuation and mistakenly uses book value weights instead of market value weights for debt and equity in WACC calculation. What is the most significant impact of this error?
- AFirm’s value could be significantly misestimated, as book values may not reflect current capital costs✓ Correct answer
- BThere will be no effect on the calculation, since weights cancel out.
- CThe DCF model will always overstate the company’s value.
- DThe DCF model will always understate the company’s value.
Explanation
Why A — Firm’s value could be significantly misestimated, as book values may not reflect current capital costs
Book values can materially differ from market values, leading to inaccurate WACC and potentially significant errors in firm valuation. It does not guarantee systematic over- or understatement.
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