Capital structure affects WACC through the weights - and those weights need to be defensible.
In Saudi markets, equity market cap can be distorted when free float is limited, and market values of debt are often not directly observable. Neither problem is insurmountable, but both require clear documentation.
Use Market Weights as the Baseline
WACC theory calls for market value weights:
- w_e = E / (D + E) - where E is market cap (or a defensible private valuation proxy)
- w_d = D / (D + E) - where D is the market value of interest-bearing debt
Estimating Debt Market Value in Practice
For floating-rate facilities and sukuk priced close to par, book value is usually a reasonable approximation of market value. For fixed-rate instruments issued under materially different rate conditions, run a sensitivity to check whether the deviation matters.
Always document the approximation used and why it is appropriate.
Target Capital Structure for Decision-Grade Valuation
When a company has an explicit financing policy - or is in the middle of deleveraging or scaling - current market weights may not represent the steady-state structure that drives long-term WACC.
In these cases, a target leverage approach is often more appropriate and more stable. Present both current and target leverage scenarios as sensitivity cases, particularly for transactions or fairness opinions where the range matters.
Free Float and Limited Market Cap Observations
For companies with concentrated ownership and a small free float, the observable market cap may not reflect the full economic value of the business. Thin float can amplify price volatility, making market-cap-based weights noisy.
In these situations, consider:
- Using a private valuation proxy for equity weight (e.g., a multiple-based estimate)
- Running sensitivity across a range of equity values
- Stating clearly what proxy was used and why
Key Principle: Avoid False Precision
Show sensitivity to capital structure weights. A ±10% shift in the equity weight changes WACC - and that change should be visible to anyone reviewing the model.
This article is for educational purposes only. It explains valuation concepts and modeling choices. It is not investment advice, a recommendation, or a financial promotion. Examples use illustrative inputs. Verify all data using primary sources and consult an appropriately licensed professional before making financial decisions.
CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute. This content is not endorsed by or affiliated with CFA Institute.
Abdul Gaffar Mohammed, CFA
Treasury & Investment Professional