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Hi John,
In calculation of WACC, you might have debt value (Vd) and equity value (Ve) available in amounts of market value ($) and in proportion (%) of debt and equity finance.
Examples:
Mve = $480
Mvd = $1.200
Debt-to-equity = 40:60I see most of answers in this sort of questions seeming to ignore the Mve and Mvd working with the Debt-to-equity ratio Vd(40) and Ve(60) in the WACC formula. Using Mve and Mvd gives a different result.
What is the correct approach for this?
You will not find answers using the ratio of debt to equity for calculating the WACC (and anyway, debt to equity in your illustration is not 40:60. Debt to equity is 1200/480!)
The ratios used are equity to total MV, and debt to total MV, which in your illustration are 480/(480 + 1200) = 28.57% for equity, and 1200/(480 + 1200) = 71.43% for debt.
If a question gives the total market values of debt and equity, then use them. If alternatively you are given debt and equity both as %’s of the total MV then use them – either way gives exactly the same answer.
Have you watched my free lectures on the cost of capital?
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