For an analyst estimating a company's target capital structure, which of the following
methods is most appropriate?
A. Apply the company’s current capital structure at book value weights
B. Use the average capital structure of a diversified group of companies
C. Infer the target capital structure by analyzing management statements on capital
structure policy
Solution
C is correct because an analyst can "[e]xamine trends in the company’s capital structure or
statements by management regarding capital structure policy to infer the target capital
structure."
A is incorrect because book value is used instead of market value. "Assume the company’s
current capital structure, at market value weights for the components, represents the
company’s target capital structure."
B is incorrect because an analyst can "[u]se averages of comparable companies’ capital
structures [not a diversified group] as the target capital structure."
Capital Structure Learning Outcome
c.Describe the use of target capital structure in estimating WACC, and calculate and interpret
target capital structure weights
