The correct answer is: D. Market value weights are fairly consistent over a period of time.
Book value weights are based on the historical cost of assets, which can be significantly different from their market value. This is because book value does not take into account changes in the market value of assets, such as changes in inflation or the overall stock market. As a result, book value weights can be very volatile and can lead to inaccurate estimates of the weighted average cost of capital.
Market value weights, on the other hand, are based on the current market value of assets. This means that they are more reflective of the true cost of capital to the company. Additionally, market value weights are more stable than book value weights, which makes them a more reliable measure of the weighted average cost of capital.
Here is a brief explanation of each option:
- Option A: Book value weights are historical in nature. This means that they are based on the historical cost of assets, which can be significantly different from their market value. As a result, book value weights can be very volatile and can lead to inaccurate estimates of the weighted average cost of capital.
- Option B: This is in conformity with the definition of cost of capital as the investors minimum required rate of return. This is not the correct answer because the definition of cost of capital is the rate of return that a company must earn on its investments in order to satisfy its investors. This rate of return can be calculated using either book value weights or market value weights.
- Option C: Book value weights fluctuate violently. This is true, but it is not the reason why market value weights are preferred. Market value weights are preferred because they are more stable than book value weights and are more reflective of the true cost of capital to the company.
- Option D: Market value weights are fairly consistent over a period of time. This is the correct answer because market value weights are based on the current market value of assets, which is more reflective of the true cost of capital to the company. Additionally, market value weights are more stable than book value weights, which makes them a more reliable measure of the weighted average cost of capital.