What components are typically included in the calculation of the Weighted Average Cost of Capital (WACC)?

• A. After-tax cost of debt, cost of equity, and their respective weights.
• B. Only the cost of equity.
• C. Only the cost of debt.
• D. Depreciation and amortization as a proxy for cost.

Answer: (A)

WACC blends the return required by all capital providers in the firm, weighted by how much each source funds the business. To do this, you need the cost of each financing component and its weight in the capital structure. For debt, you use the after-tax cost because interest expense lowers taxable income, so the effective cost to the firm is Rd × (1 − Tc). For equity, you use the cost of equity, the return demanded by shareholders given the risk. These two costs are then weighted by their shares in total financing (debt and equity) and added together to produce the WACC. Depreciation and amortization aren’t costs used in the WACC themselves, though they affect taxes and cash flows.