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

The statement asks about WACC and claims it uses the after-tax coupon rate on debt and the equity rate determined using CAPM.
First, WACC is a weighted average of the costs of financing a firm’s operations. The debt component is the after-tax cost of debt, not the coupon rate. Specifically, it uses Rd × (1 − Tc), where Rd is the cost of debt (often the yield on the firm’s debt or a market-based rate) and Tc is the corporate tax rate. The after-tax coupon rate would understate or misstate the true economic cost because coupons are paid pre-tax and do not reflect tax deductibility.
Second, the equity component is typically the cost of equity, which is commonly estimated using CAPM: Re = Rf + beta × (Rm − Rf). This part of the statement is generally accurate, as CAPM is a standard method for estimating the cost of equity.
Thus, the overall proposition is incorrect because the debt component should be the after-tax cost of debt, not the after-tax coupon rate. The elucidation of the equity cost via CAPM is correct, but the debt phrasing makes the entire statement false.
To summarize the key distinction: debt in WACC uses Rd × (1 − Tc) (after-tax cost of debt), not the after-tax coupon rate, while equity uses CAPM-derived cost Re. The misalignment in the debt term is what makes the statement false.

BU.231.740.51.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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