When one uses the after-tax weighted average cost of capital (WACC)to value a levered firm, the interest tax shield is
A)not accounted for by the use of the WACC.
B)considered by deducting the interest payment from the cash flows.
C)automatically considered because the after-tax cost of debt is included within the WACC formula.
D)capitalized by the levered cost of equity.

Question

Quizplus · Accepted Answer

The interest tax shield is automatically considered by the use of the after-tax cost of debt in the WACC formula. This is because the WACC formula calculates the cost of all capital used by the firm, including debt, on an after-tax basis. Therefore, the interest tax shield is accounted for in the calculation of the WACC without the need to deduct the interest payment from cash flows or capitalize it separately using the levered cost of equity.

When One Uses the After-Tax Weighted Average Cost of Capital