The use of market values (financial values) to weight the Weighted Average Cost of Capital (WACC) is an “unambiguous” rule, essential to reflect the economic reality of the investment.

Here are the basic reasons and terms of this rule:

1. The economic logic: The cost of returning the funds

The main justification is based on the real cost of capital for the company and its investors at a given time.

• The principle of return: If the company had excess cash and decided to repay its shareholders and creditors today (while maintaining its financial structure), it would not do so at historical book value, but at current market value. It would buy back its shares at the stock market price and repay its debt at its actuarial value.
• Opportunity cost: For the investor, the capital invested in the company is worth what he could get from it today if he sold it on the market. It is on this current value that its profitability requirement applies.
• Fundraising: Similarly, if the company were to raise new capital to finance a project, it would issue its shares at their current market value, not their historical book value.

Using book values (historical costs) would distort the calculation, as they only reflect the past and ignore the value created (or destroyed) since the beginning as well as the current expectations of investors.

2. How do you determine these values?

• For Equity (Shares): Market capitalization (Number of Shares × Share Price) is used. This is the value that the market assigns to the company’s equity.
• For Financial Debt:  The actuarial value (or financial value) of the debt is used.
  • Practical note: If interest rates have not changed much since the debt was issued and the company’s signature has not deteriorated, the book value of the debt is often considered an acceptable approximation of its financial value.

3. The special case of unlisted companies

For an unlisted company, there is no observable market capitalization. Two approaches are then possible:

1. Like-for-like estimates: The fundamental value of equity is estimated based on the valuation multiples of comparable listed companies.
2. Accounting approximation (with caution): Failing that, the accounting financial structure can be used as a first approximation, but be aware that this can underestimate the cost of equity if the real value of the company is much higher than its book value.