Hey guys,
I have a question regarding the consideration of the tax effect when calculating the WACC. I hope this question was not addressed yet - at least I didn’t find a corresponding post.
On the mock exam I saw that in some questions it is explicitly stated that the provided cost of debt is the firms before (or after) - tax cost of debt. However, in other questions there is no statement whatsoever if the provided information is the before/after-tax cost of debt (the following two questions are from the same mock exam):
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Question 1: A firm’s before-tax costs of debt, preferred stock, and equity are 12%, 17%, and 20%, respectively. Assuming equal funding from each source and a marginal tax rate of 40%, the weighted average cost of capital (%) is closest to:
Question 2: A firm’s estimated costs of debt, preferred stock, and common stock are 12%, 17%, and 20%, respectively. Assuming equal funding from each source and a marginal tax rate of 40%, the weighted average cost of capital (WAAC) is closest to:
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Can I expect that in the exam it is always clear if I need to consider the tax effect when calculating the WACC? Tbh from question 2 it would not be clear to me and I would rather expect that I am dealing with after-tax cost of debt since there is no information that supports the fact that it is the before tax cost of debt. However, according to the answer to question 2 I still need to take the tax effect into consideration.
Any advice?
Thanks in advance!
