The comment by Linke and Kim correctly observes that the assumption regarding the maintenance of constant proportional use of capital sources is not appropriate for our argument and should be deleted. As our analysis did not make use of this assumption, the two conclusions hold.1. The weighted average cost of capital calculated with the usual weights (original capital structure proportions) is not in general equal to the discount rate which equates the current value of the firm to the present value of future cash flows.2. The above conclusion holds for any weights which can be constructed from the cash flows.

The weighted average cost of capital is a widely used concept in the theoretical literature of finance as well as in the analysis of capital expenditures of business firms. The importance of the concept derives from its use as the cutoff point for investment in capital projects and as an indicator of optimal capital structure. Differences between the weighted average cost of capital and the true overall cost of capital are typically attributed to deviations of market values from book values, changes in the proportional use of specific capital sources, or alterations in the risk characteristics of the stream of payments to owners and creditors. This paper abstracts from the aforementioned problems to focus on the mathematical error of using weighted average cost of capital to represent the true overall capital cost. It is determined that, in general, the calculation of weighted average cost leads to an erroneous value of the minimum acceptable level of return. The fault lies in the general inability to express the root(s) of a polynomial as an algebraic combination of the roots of other related polynomials.

Approaches to Valuation. Estimation of Discount Rates. Estimation of Cash Flows. Estimation of Growth Rates. Dividend--Discount Models. Free--Cash--Flow--to--Equity Discount Models. Valuing a Firm--The Free--Cash--Flow--to--Firm Approach. Special Cases in Valuation. Price/Earnings Ratios. Price/Book Value Ratios. Price/Sales Ratio. Management Decisions, Corporate Strategy, and Firm Value. Valuation for Acquisitions and Takeovers. Option--Pricing Theory. Applications of Option--Pricing Theory to Valuation. Overview and Conclusion. Appendices. References. Disk Documentation. Index.