When weighted average cost of capital (WACC) is used to value a levered firm, the interest tax shield is:
A) ignored.
B) considered by deducting the interest payment from the cash flows.
C) automatically considered because the after-tax cost of debt is used in the WACC formula.
D) none of the above

Question

Quizplus · Accepted Answer

The interest tax shield is automatically considered in the WACC formula when the after-tax cost of debt is used. This is because the WACC formula includes weights for the firm's cost of equity and cost of debt, which reflect the proportion of financing provided by each source. The after-tax cost of debt reflects the benefit of the interest tax shield, as it reduces the overall cost of debt financing. Therefore, the interest tax shield is already accounted for in the WACC calculation.

When Weighted Average Cost of Capital (WACC) Is Used to Value