medium · Principles of Finance capital-budgeting
How does using market value weights for WACC reflect the 'Capital Rationing' environment of a firm?
- Using market weights mechanically increases the NPV of all projects under review, helping the firm justify accepting more marginal investments.
- Market weights ensure the WACC reflects the actual cost of raising the next dollar of capital, which is the relevant hurdle rate for rationed funds.
- Capital rationing only arises as a scenario when a firm's book values happen to exceed its corresponding market values across the balance sheet.
- It doesn't; capital rationing is purely an internal budgeting constraint that is entirely unrelated to prevailing external market prices or rates.
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