DCF - % debt and % equity?
So I'm learning DCF and have a couple questions that I can't find solid answers to:
1 - during WACC calculation when we calculate % debt and % equity in capital structure we are supposed to use MV not BV for both right? For debt BV is a good proxy but for equity it has to be MV?
2 - I know that one option for capital structure is to use target capital structure. But assuming we choose to keep it as it is - do we use this year's % debt and % equity or final projected year's?
3 - when subtracting net debt at the very end - again where does this figure come from? this year's? last projected year's? target?
On a side note - what is the single best read about DCF? I did Rosenbaum and macabacus - are there any other sources I should consult? Especially interested in explanation behind WHY things are the way they are.
You should ideally use MV for both, but in a normal situation debt can be a proxy for BV. You definitely do not want to use BV of equity in understanding capital structure. For most companies, the book value of equity has little to do with the current value of the firm. Think like a potential bond investor: If Facebook came out with an offering for $18B of bonds, would you be thinking of the riskiness of lending FB $18B in the context of its $222B market cap or in the context of its $36B book value? For a company the market assesses as being worth $222B, is $18B of debt risky? Clearly no, but looking at that bond offering vs. the current book equity makes it look like it is.
Your judgment call. Do you want the value of the firm with the current capital structure, or its value under a different capital structure that may be more optimal? I'd say it depends on why you are creating this DCF. As a passive equity investor valuing the company, I have no control over its capital structure; thus, I would not be comfortable valuing the company under a more optimistic structure. As a control buyer, I would have sway over the capital structure and would like to evaluate various alternatives.
Current
This may be helpful, or other things from Damodoran: http://people.stern.nyu.edu/adamodar/pdfiles/eqnotes/packet1apg2.pdf
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