In a previous article, I explained how we can use an iterative approach to reach value estimates that give consistent values whether we use the equity approach or the invested-capital approach to firm valuation. In response to that article, Alix Mandron wrote that these methods do not work correctly. This article is in response to Mandron's criticisms. Dr. Mandron's main points were (a) that we should use book values in computing capital proportions in both WACC and the cost of equity and (b) WACC is in error and the equity method, with the cost of equity based on book values, should be used in preference to the invested-capital method that uses WACC. This paper explains errors in Dr. Mandron's arguments. The main point of the article is that both the invested-capital method and the equity method can be equally valid, but it is important to apply these methods in a way that is consistent with the assumptions that were used when they were developed. This includes the requirement that we use equilibrium market values in calculating the capital ratios in the cost of capital formulas.
