Which statement correctly describes the components used to compute the weighted average cost of capital (WACC)?

• A. WACC is determined by the cost of debt alone
• B. The cost of equity and after-tax cost of debt, with their weights, determine WACC
• C. WACC uses only the debt portion
• D. WACC is a fixed rate set by market conditions

Answer: (B)

WACC measures the blended cost of financing from both equity and debt, weighted by their market values and adjusted for taxes. It combines the cost of equity (the return investors require on the firm’s stock) with the after-tax cost of debt (the interest expense on borrowings, reduced by the tax shield). The weights come from how much of the firm’s financing comes from equity versus debt in market terms, not from a single source. This means WACC is calculated using both components together: (weight of equity) times (cost of equity) plus (weight of debt) times (cost of debt after tax). Because debt benefits from tax deductibility, the after-tax cost of debt is Rd*(1 - Tc). WACC is not a fixed rate set by market conditions nor the cost of just one financing source, but the weighted combination of both costs.