Inconsistent estimates of weighted-average costs of capital. Suppose you compute the present…

Inconsistent estimates of weighted-average costs of capital. Suppose you compute the present value of free cash flows to all debt and equity capital using the weighted-average cost of capital as a discount rate and then subtract the present value of debt and preferred stock to determine the present value of common equity (as shown in Chapter 12). The only way the value estimates from this approach will be identical with value estimates from the residual income approach or the dividends approach is if the weighted-average cost of capital uses weights that are perfectly internally consistent with the present values of debt, preferred stock, and common equity. Thus, you may have to iterate the computation of the weighted-average cost of capital a number of times until all of the weights and present values are internally consistent.

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