This article clarifies some of the issues raised by the author in an earlier article. It is also a reply to criticisms advanced by J. Morris. Regarding the controversy of book versus market-value weights, it is shown that, aside from not being grounded in proper theory, market-value weights computed through iterations are not even needed: in simple cases, they yield exactly the same result as noniterated, nonmarket-value weights, provided the latter are used in the cost of equity, or COE (and not in the weighted average cost of capital, or WACC). The article makes it clear that the appropriate nonmarket-value weights are not straight accounting book value weights. For want of a better term, the relevant weights are called “adjusted book-value weights.” Regarding the WACC, the mathematics is plain: the WACC does assume that cash flows are shared, and reinvested, according to the weights it is built on. This feature explains why, in more complex cases (for example those involving a changing capital structure), iterated market value-based WACCs give the wrong answer: the iterative models required to solve these problems are recursive; the recursive feature is what prevents them from dealing appropriately with the reinvestment assumption. The direct equity valuation formula at adjusted book value–based COEs provides the only easy (and accurate) solution. Adjusted book value–based WACCs should be avoided because they, too, suffer from the inappropriate proportional sharing assumption.
