The total market value of Downunder Minerals is $10 billion. The company has a market value of $7 billion of equity and a face value of $10 billion of debt. What are the weights in equity and debt that are used for calculating the WACC?

Question

Quizplus · Accepted Answer

The weights in equity and debt are calculated as:
Equity weight = Market value of equity / Total market value
Debt weight = Market value of debt / Total market value

Using the numbers given:
Equity weight = 7 billion / 10 billion = 0.7
Debt weight = 10 billion / 10 billion = 1

Note that the debt weight is more than 1, which is not possible. This is because it is specified in the question that the face value of debt is 10 billion, which means that this is the amount that the company borrowed. However, the market value of debt can be different from the face value, depending on factors like interest rates and the company's creditworthiness. 
Therefore, we must adjust the debt weight to reflect the market value of debt. Without any information about the market value, we can assume that the market value of debt is equal to its face value. In this case, the debt weight would be 10 billion / 10 billion = 1.

Thus, the weights are 0.7 for equity and 0.3 for debt, giving us choice B.

The Total Market Value of Downunder Minerals Is $10 Billion