Mechanics of Computation
We now illustrate the mechanics of computation of the weighted average cost of capital.
Weighted Average Cost of Capital (Marginal Weights)
This costs substantially lower than the weighted cost calculated using either book values or market values of historical weights. This is because debt finance has been used in large amount. Since only a limited amount of debt financing can be raised for a given equally base, it is quite that the firm will have to use primarily expensive equity financing for future projects. Obviously, this is not a happy situation because a project which gives a return of, say, 12 per cent is year will be accepted as the 11 per cent but next year another project which may be a higher return might have to be rejected equity financing will imply entail a higher. The use of historical market value weights in calculating is much more likely to lead to an optimal selection of capital investment project in the long run and, therefore, it should be referred as the basis of an signing weights to calculate the composite cost of capital.