The weight of debt and equity are important components of the WACC. The WACC which you use as your discount rate in most DCF models plays a big role in the resulting valuation. It is important to get this right. Would you prefer to use the market value weights or book value weights of debt and equity to arrive at the weights when computing WACC?
You use the market value of debt and equity to compute the weights of debt and equity in estimating WACC. This is because of several reasons.
First, book value is arrived at using financial accounting principles and related regulations. Financial accounting is backward-looking. Therefore, the book values will not reflect actual values today.
Second, book values could result in negative values for equity in loss-making firms.
Third, you are valuing to understand today’s value. Market values reflect today’s values and so are preferable.
Fourth, you are valuing the business for a buy or sell valuation decision and so it should reflect today’s prices rather than prices paid.