Thestraightbondcomponentof$630istreatedasdebt,while
theconversionoptionof$434istreatedasequity (1064−
630).
Weights for Computing Cost of Capital
Oncewehavecostsforeachofthedifferentcomponentsof
financing, all we need are weights on each component to
arriveatacostofcapital.Inthissubsection,weconsiderthe
choicesforweighting,theargumentforusingmarket value
weights, and whether the weights can change over time.
Choices for Weighting
Incomputingweights fordebt,equity,andpreferredstock,
wehavetwochoices.Wecantaketheaccountingestimatesof
thevalueofeachfundingsourcefromthebalancesheetand
compute book valueweights. Alternatively, we canuse or
estimate market values for each component and compute
weightsbasedonrelativemarketvalue.Asageneralrule,the
weights used in thecost of capital computationshould be
basedonmarketvalues.Thisisbecausethecostofcapitalisa
forward-lookingmeasureandcapturesthecostofraisingnew
fundstobuythefirmtoday.Sincenewdebtandequityhave
to be raisedin themarket atprevailing prices,themarket
value weights is more relevant.