What will be the effect of using book value of debt in WACC decisions if interest rates have decreased substantially since a firm's long-term bonds were issued?

Question

Quizplus · Accepted Answer

When interest rates decrease substantially after a firm's long-term bonds were issued, the market value of these bonds increases because they pay a higher interest rate than newly issued bonds. Using the book value of debt, which does not account for this increase in market value, will understate the debt component in the debt-to-value ratio. This is because the book value remains constant based on the original issue price, while the market value would reflect the increased worth of the debt due to higher interest payments compared to the current market rate.

What Will Be the Effect of Using Book Value of Debt