WACC uses the after-tax coupon rate on debt and the equity rate determined using CAPM. True or False?

Question

WACC uses the after-tax coupon rate on debt and the equity rate determined using CAPM.  True or False?

BlackTom AI · Accepted Answer

When evaluating a statement about WACC, we should parse what components it claims to use and how they are normally determined.
Option: True. The claim asserts that WACC uses the after-tax coupon rate on debt and the equity rate determined using CAPM.
- First, the notion of an after-tax coupon rate on debt is problematic. In practice, the cost of debt used in WACC is the after-tax cost of debt, but it is not typically the coupon rate. The coupon rate is an fixed-rate payment laid out in the bond's terms, whereas the cost of debt in WACC reflects the market-based borrowing cost (often approximated by yield to maturity or another market-based measure) after taxes. Therefore, equating WACC debt cost to the after-tax coupon rate is misleading because coupons are not the market cost of debt.
- Second, the statement says the equity rate is determined using CAPM. This part is generally true in many standard WACC calculations, where the cost of equity is estimated via CAPM (cost of equity = risk-free rate + beta × (market return − risk premium)). However, the overall accuracy of the statement is undermined by the incorrect debt component.
- Additionally, CAPM-based cost of equity is one common method, but not the only method; some models may use dividend discount models or other approaches. Yet since the debt component is already incorrect, the entire statement cannot be considered true.
Option: False. The corrected understanding is that WACC uses the after-tax cost of debt (not the coupon rate) and an equity cost that can be determined by CAPM among other methods. The due-diligence point is recognizing that debt is priced in the market and after taxes, and the coupon rate is not the standard input for WACC. 
In summary, the main pitfall lies in confusing the coupon rate with the market-based cost of debt after tax; CAPM is a plausible method for the equity side, but the debt component as stated does not align with how WACC is typically computed.

BU.231.740.52.SP25 Homework #4

WACC uses the after-tax coupon rate on debt and the equity rate determined using CAPM. True or False?

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