When computing the weighted average cost of capital, which of these are adjusted for taxes? OCost of preferred stock Both cost of debt and cost of equity Cost of equity Both cost of debt and cost of preferred stock Cost of debt
When computing the weighted average cost of capital, which of these are adjusted for taxes? OCost of preferred stock Both cost of debt and cost of equity Cost of equity Both cost of debt and cost of preferred stock Cost of debt
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:### Understanding Tax Adjustments in Weighted Average Cost of Capital (WACC)
#### Question:
When computing the weighted average cost of capital, which of these are adjusted for taxes?
- ○ Cost of preferred stock
- ○ Both cost of debt and cost of equity
- ○ Cost of equity
- ○ Both cost of debt and cost of preferred stock
- ○ Cost of debt
#### Explanation:
The weighted average cost of capital (WACC) is a calculation used by companies to determine the average cost of financing their operations from all sources, considering the proportion of each source in the overall capital structure. This often includes equity, debt, and preferred stock.
In calculating WACC, the cost of debt is typically adjusted for taxes because interest expenses are tax-deductible. This means that the effective cost of debt is lower than the nominal cost because the company can deduct interest payments from its taxable income.
**Key Concept:**
- **Cost of Debt Adjustment**: Since interest on debt is a tax-deductible expense, the cost of debt is adjusted to reflect the tax savings from this deduction. This adjustment is not typically applicable to the cost of equity or preferred stock, as dividends from these sources are not tax-deductible.
Understanding these adjustments is crucial for accurately assessing the cost of capital and making informed financial decisions.
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