In the WACC calculation, the weights should ideally be based on:

Question

Accepted Answer

Market values of debt and equity. The weights in the WACC calculation should ideally be based on market values of debt and equity because they reflect the current economic cost of each financing source. Market values represent what investors would actually pay for the company's securities today, making them the most relevant measure for forward-looking cost of capital calculations.

Book values of debt and equity reflect historical accounting entries that may significantly differ from current market values, especially for equity, which can appreciate substantially over time. Historical costs are backward-looking and do not represent the current opportunity cost of capital that investors face. Par values of debt and equity are nominal face values that may bear little resemblance to actual market prices - bonds frequently trade above or below par, and equity par values are often nominal (like $1 per share).

Understanding the preference for market-value weights is important for the DSST exam. In practice, many companies use book values because market values fluctuate daily, but theoretically, market values are superior because WACC is used to make forward-looking investment decisions. Students should be prepared to calculate WACC using either method but should know why market values are preferred.

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