I thought I'd bring my inquiries here.Let's talk theory first, and let's start with discount rates before moving on.In determining the market value of equity, you need to first calculate the market value of all operating and non-operating assets, then subtract all non-common equity claims to get your MV of equity.Let's say you have the fair value of all the assets given from the publicly traded market (trying to work around discount rates for now). Then why do we subtract the MV of all non-equity claims (let's assume it's just debt) from the MV of assets to get the MV of equity? If the claims of a bond are the face value of the debt, then in the event of default, the creditor would only have claims equal to the face (book) value of the debt, not it's market value. To illustrate my point better, if the credit rating of the all the groups of assets (a firm) improve, then the MV of that debt will increase, leaving equity worth less. And if interest rates go up a lot, then the MV of that debt will go down, and equity will be more highly valued. Do we still use the opportunity cost of debt in determining the market value of equity, or only the value of claims on that debt (face value).Which brings me to my next point for the WACC. Why do practitioners use the marginal cost of debt and market value of debt? If the current cost of debt (Kd) is less than the marginal, let's say, 10 years from now, then it would underestimate the value of the firm. Shouldn't we use a gradual target of the Kd that reverts to the marginal rate over time, leaving the current Kd for the most recent years fairly the same?Third question, why do we use the MV of debt in calculating the weights of the WACC. I know it's based on "opportunity cost" which means that this is the value of debt it would bear if it would re-finance all of it today. But that's not realistic, and certainly that MV would change over time as fundamentals change as well, so that number is not relevant at all. And last question. In calculating the MV of equity, why do we use the current market cap? Isn't that value based on the 'stock market' and not the real fair value? Why does it assume that all stocks can be purchased at the current price? Even if we assume this is true, the equity value we calculate in the end should be the 'real' MV and should be used in the WACC, leaving us in an iteration process of chasing a MV that leaves in unchanged in a loop?Thanks!

At least answer me this.Do we use the current market cap in deriving the weight of equity in the WACC? Or use an iterative process whereby the arrived at value keeps replacing the market value of equity in the WACC until a steady state has been reached? Then use a gradual convergence towards the "target weights".Anyone?

I should think you would want to use the notional values because they are the actual quantities that the firm pays market rates on. A firm doesn't make debt interest payments on the market value debt amounts, do they?