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When computing the weighted average cost of capital, which of these are adjusted for taxes?

Question

When computing the weighted average cost of capital, which of these are adjusted for taxes?

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Solution

The cost of debt is adjusted for taxes when computing the weighted average cost of capital. This is because interest expenses are tax-deductible, which effectively reduces the cost of debt. This tax shield is taken into account by multiplying the cost of debt by (1 - tax rate). The cost of equity, however, is not tax-adjusted because equity dividends are paid out of after-tax income.

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