WACC Calculation and Taxes
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Which portion of the WACC calculation is impacted by taxes? How can a company reduce its cost of capital? How is WACC used in financial planning to optimize capital structure?
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Solution Summary
This solution defines the cost of capital and the weighted average cost of capital (WACC) in terms of capital structure. It also describes how companies can reduce the cost of capital and how taxes affect the WACC.
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The cost of capital is the required rate of return that a firm must achieve in order to cover the cost of generating funds in the marketplace. Another way to think of the cost of capital is as the opportunity cost of funds, since this represents the opportunity cost for investing in assets with the same risk as the firm. When investors are shopping for places in which to invest their funds, they have an opportunity cost. The firm, given its riskiness, must strive to earn the investor's opportunity cost. If the firm does not achieve the return investors expect (i.e. the investor's opportunity cost), investors will not invest in the firm's debt and ...
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