Question

The weighted average cost of capital for a firm:

A. remains constant when the firm’s capital structure changes.

B. is unaffected when there is any change in the corporate tax rate.

C. is equivalent to the after-tax cost of the firm’s outstanding debt.

D. is a weighted average between the cost of equity and the (after-tax) cost of debt.

Answer 1

Answer :

D. is a weighted average between the cost of equity and the (after-tax) cost of debt.

Note:

1. The weighted average cost of capital for a firm indicates the cost of capital taking in consideration the weight of equity and debt and their respective costs.

WACC is computed as = (Cost of Debt * Weight of Debt) + (Cost of Equity * Weight of Equity)

2. The weighted average cost of capital for a firm fluctuates when the firm’s capital structure changes because the weights are multiplied by the cost of respective sources.

3. The weighted average cost of capital for a firm is affected when there is any change in the corporate tax rate because the after tax cost of debt changes.

4. The weighted average cost of capital for a firm is not only equivalent to the after-tax cost of the firm’s outstanding debt. It also considers the equity and preferred stock.