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Hi, Mr John! I have a question relating WACC calculation. Do we include retained earnings in the calculation of Book Value WACC? In BPP Revision Kit there is a question (Tinep Co (12/14, amended, page ?57)). There they included retained earnings. I thought we should only include Ordinary share capital, Preference shares and Loan notes in both Book Value and Market Value WACC calculation.
The book value of equity is the share capital plus the retained earnings.
When taking the market value of equity we do not add on retained earnings (because the most obvious reason for the market value being higher than the book value is because of retained earnings – they are effectively taken into account in the market value).
This is the only exam question there has been where you have been asked to calculate a book value WACC because it is fairly meaningless. We always use market values unless specifically told to do differently.
The most likely place that book values and market values are relevant for the exam is in calculations of the gearing ratio, where the same ‘rule’ applies as I have written above (and as I explain in my free lectures).
So you mean the rule is: Book value of Equity-Ordinary share capital plus Retained earnings, Market value of Equity-Market value of Ordinary shares in issue (i.e. Market Capitalisation).
Thank you so much. I really appreciate your help.
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