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When calculating WACC How do I know when to use target capital structure (e.g. 60%/40%) and when actual Equity/debt values from Statement of financial position?
It depends on the purpose for which you are calculating WACC. The proper calculation of WACC implies market values of debt and equity. If this is being calculated for investment appraisal and the company intends to move quickly to a target ratio, then use the target. If you are looking back over performance to calculate EVA, then the target rate is not relevant. You need to deduct the WACC calculated using the actual debt:equity ratio as that cost of the capital that has to be covered to see if there is any value added.
Thank you for a quick response! Question ALPHA DIVISION in Dec 07 asked to calculate EVA for a group for 2006 and 2007. The answer used target capital structure. I used the actual because just like you mentioned above why use target when assessing actual. And in this question actuals were nowhere near the target plus the equity increased in 2007. Therefore I thought that using actuals is important to see capture the equity increase on how the group performed. this is i am confused.
You would have a problem taking your approach in this question:
1 You do not know the market values of debt and equity (essential for WACC)
2 You do not know the make up of the capital of $279m at the end of 2005/start of 2006.
The only option, therefore, is to use the target WACC.
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