Why market values, always? Because WACC asks what return investors require on the capital tied up at today's prices. An investor buying the whole company today pays market value, and the accountant's history doesn't enter into it. Book equity is decades of retained earnings and buyback accounting, and it's sometimes negative. US serial repurchasers like Home Depot report negative book equity while being worth hundreds of billions. Book weights there produce literal nonsense, a D/E below zero. Book debt at least approximates reality. Book equity doesn't even try.
E: market value of equity. Shares outstanding × price. Include every listed class, such as DVRs in India and dual classes in the US. Use the current price and skip averages, because WACC is a today number. For option-heavy firms you can add the value of employee options, and the per-share bridge in the DCF work handles dilution properly.
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What counts as debt, and how do you mark it to market?
D: market value of interest-bearing debt. Debt means short- and long-term borrowings, current maturities, bonds, term loans, plus lease liabilities. Under IFRS 16 and Ind AS 116 all leases are on the balance sheet as debt. Under ASC 842, finance and operating lease liabilities are both on the balance sheet. Include both in debt. That operating-lease line is a fixed, contractual, debt-like claim. Leaving it out flatters US retailers and airlines against their Indian IFRS cousins. That's the comparability trap from the liabilities work, now with valuation consequences. Some things don't count: accounts payable, accrued wages, deferred revenue (operating items, handled inside working capital), deferred taxes, ordinary provisions.
What about converting book debt to market? Book ≈ market when the firm is healthy and rates haven't moved much since issuance, and that's the standard default. When rates have moved or credit has deteriorated, mark it. Treat the entire book debt as one bond, with coupon = current interest expense, face = book debt and maturity = the weighted-average maturity from the debt note. Then price it at today's cost of debt, using the annuity machinery from the time-value work:
MV(debt) ≈ Interest × [1 − (1+Rd)^−M] / Rd + Book debt / (1+Rd)^MWorked Example 3 runs the numbers. As a direction check, when rates go up, old fixed-rate debt is worth less than book, so the debt weight falls.
How do you treat preferred stock in WACC?
P: preferred stock, the third leg. Where preferred shares are outstanding, they're neither debt nor common equity. They need their own weight and their own rate. That rate is the perpetuity inversion from the time-value work: Rp = preferred dividend ÷ preferred market price. A ₹100-face 8.5% preference share quoted at ₹92 costs 8.50/92 = 9.24%. No (1−t) appears anywhere, because preferred dividends are paid out of after-tax profit and shield nothing. If the shares are callable, price to the call. Use that yield in place of the perpetuity one. Your assembly becomes WACC = (E/V)·Re + (P/V)·Rp + (D/V)·Rd·(1−t), with V the sum of all three at market. Take a build with ₹46,000 cr of equity, ₹2,000 cr of preferred and ₹12,000 cr of debt (Re 13.2%, Rd 8.6%, tax 25%). Its three-leg WACC is 11.72%, against 11.80% if you ignore the preferred and re-weight. The gap is 8 basis points, which is small. When preferred is under a few percent of capital, folding it into debt at its own rate and saying so in a note costs the answer almost nothing. When it's ten or twenty percent, as in some US utilities and in Indian promoter recapitalizations, you can't skip the third leg.
Gross or net debt, and current or target weights?
Gross or net debt? There are two coherent conventions. You can put the weights on gross debt, valuing operations and then adding cash back in the equity bridge, or on net debt, which is debt minus cash. We use gross debt in WACC and handle cash explicitly in the DCF bridge, which you'll build when you get to free cash flows. One method, everywhere. Mix conventions mid-model and you double-count cash, which is error #7's favorite disguise.
Current or target weights? By default, use today's market weights. Use a target structure only when the migration is credible and observable, such as a signed de-levering plan after an acquisition, or a stated net-debt/EBITDA target that management has actually tracked toward. And notice the small circularity. You need equity value for the weights, but the DCF outputs equity value. For listed firms, market cap resolves it, because the market's estimate is your weight input, even if your DCF disagrees with the level. For private firms, iterate. Guess the weights and value the firm, then recompute the weights from that value. It converges in two or three rounds. You'll wire this into the model properly in the three-statement modeling work.