Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVI. Cost of Capital and
Long−Term Financial
Policy(^534) 15. Cost of Capital © The McGraw−Hill
Companies, 2002
WACC .69 10.28% .31 7.38% (1 .35)
8.58%
Thus, using market value weights, we get almost 8.6 percent for Eastman’s WACC,
which is almost a full percentage point higher than the 7.7 percent we got using book
value weights.
As this example illustrates, using book values can lead to trouble, particularly if eq-
uity book values are used. Going back to Chapter 3, recall that we discussed the market-
to-book ratio (the ratio of market value per share to book value per share). This ratio is
usually substantially bigger than 1. For Eastman, for example, verify that it’s about 2.0;
so book values significantly overstate the percentage of Eastman’s financing that comes
from debt. In addition, if we were computing a WACC for a company that did not have
publicly traded stock, we would try to come up with a suitable market-to-book ratio by
looking at publicly traded companies, and we would then use this ratio to adjust the
book value of the company under consideration. As we have seen, failure to do so can
lead to significant underestimation of the WACC.
Our nearby Work the Webbox explains more about the WACC and related topics.506 PART SIX Cost of Capital and Long-Term Financial Policy
So how doesour estimate of the WACC for Eastman compare to oth-
ers? One place to find estimates for WACC is http://www.stockbasics.com. We
went there and found the following information for Eastman.The most recent information on StockBasics for Eastman when we checked was the
end of 2000. As you can see, StockBasics estimates the WACC (Cost of Capital) for
Eastman as 8.73 percent, which is very close to our estimate of 8.58 percent. The
methods used by this site are not identical to ours, but they are similar in the most im-
portant regards. You can visit the site to learn more if you are so inclined.Work the Web