## WACC: Book Value vs Market Value Weights — A Comparative Analysis
The same company will report different WACCs depending on whether BV or MV weights are used. Understanding why they differ, and which is more appropriate, is a common exam requirement.
### Key differences
| Dimension | Book Value Weights | Market Value Weights |
|---|
| Basis | Balance sheet amounts | Current market prices |
| Stability | More stable over time | Fluctuates with market |
| Ease | Simple to compute | Requires current prices |
| Accuracy | May be outdated | Reflects current cost |
| Recommended by | Practitioners (convenience) | Finance theorists |
### Treatment of retained earnings
- BV weights: Retained earnings appear as a separate line item (e.g., ₹30 lakh retained earnings → separate weight assigned with cost = Kr)
- MV weights: No separate market value for retained earnings. The equity share price already capitalises all shareholder claims including retained earnings. Assign zero weight to retained earnings; absorb them into equity.
### Which WACC to use?
- Market value WACC is preferred for evaluating new investments, since it reflects the current opportunity cost of capital
- Book value WACC may be used internally for historical performance measurement or regulated returns
### Example 1
Q42 / Q35 – Best Luck Ltd. / Ex Ltd. (BV vs MV WACC)
Book values: Equity ₹1,20L, Retained ₹30L, Pref ₹36L, Deb ₹9L; Total ₹1,95L
Market values: Equity ₹2,00L (130/share), Pref ₹33.75L, Deb ₹10.40L; Total ₹2,44.15L
Individual costs:
- Ke (new issue): D1/(NP)+g = 15/(125−5)+g
Growth: Dividends grew from ₹10.60 to ₹14.19 over 5 years → g = (14.19/10.60)^(1/5)−1 = 6%
Ke = 15/120 + 6% = 12.5% + 6% = 18.5%
- Kr (retained earnings): D1/P0+g = 15/130 + 6% = 11.54% + 6% = 17.54%
- Kp: 15% pref, NP=105, RV=100, n=11yrs, flotation 2% on face (₹2)
Approx Kd style: [15+(100−105)/11]/[(100+105)/2] = [15−0.45]/102.5 = 14.19%
(Note: no tax on preference dividends)
- Kd: 15% deb, market yield 16%, flotation 2% on face
Kd(after tax, 35%) use YTM at 16% market yield and adjust: this is a 11-yr deb
Kd ≈ 16%(1−0.35) = 10.4% is approximate when market YTM = 16%
Exact: issue at NP = 98 (100−2% flotation), RV=100, coupon=15%, n=11, tax=35%
After-tax coupon = 9.75; Kd = [9.75+(100−98)/11]/[(100+98)/2] = [9.75+0.18]/99 = 9.93%
BV WACC:
| Source | BV | Weight | Cost | WC |
|---|
| Equity | 1,20 | 0.615 | 18.5% | 11.38% |
| Retained | 30 | 0.154 | 17.54% | 2.70% |
| Pref | 36 | 0.185 | 14.19% | 2.62% |
| Deb | 9 | 0.046 | 9.93% | 0.46% |
| Total | 195 | | | 17.16% |
MV WACC:
| Source | MV | Weight | Cost | WC |
|---|
| Equity (incl.retained) | 200 | 0.819 | 18.5% | 15.15% |
| Pref | 33.75 | 0.138 | 14.19% | 1.96% |
| Deb | 10.40 | 0.043 | 9.93% | 0.43% |
| Total | 244.15 | | | 17.54% |
MV WACC > BV WACC here because equity (the most expensive source) has a higher weight at market value.