Aswath Damodaran 316
Issue: Use of Book Value
Many CFOs argue that using book value is more conservative than using market
value, because the market value of equity is usually much higher than book
value. Is this statement true, from a cost of capital perspective? (Will you get
a more conservative estimate of cost of capital using book value rather than
market value?)
# Yes
# No
No. In most countries, including the US, the market value of equity is far higher
than the book value of equity, while the market value of debt tends to be closer
to the book value of debt.
Using book value weights results in a lower weight for equity and a higher
weight for debt. Since the cost of equity is much higher than the cost of debt, the
cost of capital, based on book value weights, will be much lower than that
computed using market value weights. Since this is the hurdle rate used to
decide whether to take projects or not, it is less conservative to use book value
weights.
