Second-generation biofuels produced from inedible feedstocks may be a viable alternative to diesel fuel and the transformation of the seeds into biodiesel has been the subject of some exciting studies in the Bauhinia family. However, none of the studies attempted to optimise the transesterification process parameters of Bauhinia racemose biodiesel (BRB) for a higher yield rate and analyse the BRB compatibility with water emulsion. The current research thereby optimises the process parameter variables for a higher yield rate of BRB, characterises the fuel, and explores the effect of water emulsion in BRB on combustion, performance, and environmental features. The transesterification process was started with a reusable catalyst, and its various parameters were optimised to achieve maximum efficiency. The optimal input parameters, according to the optimisation are a molar ratio of 8.11:1, a reaction temperature of 66.04 °C, and a reaction time of 115.2 min; under these conditions, the yield rate of BRB is 92.9%. The Fourier-transform infrared spectroscopy examination suggests that the carbon-based elements of the developed BRB appear to be in excellent order, and according to data from gas chromatography–mass spectrometry, methyl esters contribute most significantly. The plain diesel (PD) was first blended with 10%, 20%, and 30% volume of BRB, and then 5% and 10% volume of water were added to the 30% BRB-blended PD. The experiments were carried out in a diesel engine under various operating conditions. Maximum in-cylinder pressure is 3.4% lower for PD that has been blended with 30% BRB, while it is 2.41% higher when 10% water is added. Both the rate of heat release and the time it takes to burn is reduced in BRB blends of PD and water-emulsified fuels. Adding 30% BRB mixed PD decreases brake thermal efficiency (BTE) by 3.2%, and 10% water-emulsified BRB improves BTE by 3.9%. When BRB is used with PD, all emissions are mitigated, except for oxides of nitrogen (NOx). NOx emissions can be reduced by 12.1% when fuel is emulsified in 10% water. In addition, the proposed fuel mixture will reduce demand for regular diesel fuel by about 40%.