Question

6. Why do we use market values rather than book values in calculation of WACC?

Dr. Pepper, a manufacturer of beverages, is planning to purchase Canada’s Wonderland theme park. Should Dr. Pepper use its own WACC as the discount rate to evaluate the business of Canada’s Wonderland or should it use Canada’s Wonderland’s WACC? Explain your answer.

Answer 1

While calculating WACC, market values are preferred over book values. Book values are historical and do not convey the actual return required by different providers of capital. Thus, while valuing a company, it is more appropriate to use market values instead of book values.

Dr. Pepper should use its own WACC as discount rate to evaluate the business of Canada's Wonderland because, Dr. Pepper's debt and equity holders would provide capital for the acquisition and thus Dr. Pepper's WACC would be the appropriate discount rate.