A company has a capital structure of 60% Equity and 40% Debt. Its Cost of Equity (Ke) is 14.0%, Pre-Tax Cost of Debt is 8.0%, and the corporate tax rate is 25%. What is the firm's Weighted Average Cost of Capital (WACC)?

[ A ]10.80% [ (We * Ke) + (Wd * Kd * (1 - t)) = (0.60 * 14.0%) + (0.40 * 8.0% * 0.75) ][ CORRECT ]

[ B ]11.60% (Using pre-tax cost of debt without tax shield)

[ C ]11.00%

[ D ]14.00% (Cost of equity alone)

Takeaway

Option A is correct: 10.80% [ (We * Ke) + (Wd * Kd * (1 - t)) = (0.60 * 14.0%) + (0.40 * 8.0% * 0.75) ]

Derivation

WACC blends the cost of each source of capital, weighted by its share of the capital structure. The equity component: Weight (0.60) × Cost of Equity (14.0%) = 8.40%. The debt component requires one extra step before weighting it: because interest expense is tax-deductible, the effective cost to the firm is lower than the quoted pre-tax rate, so Kd must first be tax-adjusted: 8.0% × (1 − 0.25) = 6.0% after-tax. Then weight it: 0.40 × 6.0% = 2.40%. Summing both components: WACC = 8.40% + 2.40% = 10.80%. Skipping the tax adjustment on debt and using the raw 8.0% pre-tax rate instead is the single most common error on this calculation, since it ignores the interest tax shield that makes debt genuinely cheaper than its quoted rate.

Why the others fail

B — 11.60% (Using pre-tax cost of debt without tax shield)

Uses the raw pre-tax cost of debt of 8.0% without applying the tax shield adjustment, ignoring that interest expense reduces the firm's effective tax bill.

C — 11.00%

Averages the cost of equity and pre-tax cost of debt directly rather than weighting each by its actual share of the capital structure and tax-adjusting debt.

D — 14.00% (Cost of equity alone)

Reports the cost of equity alone, ignoring that 40% of the capital structure is debt, which pulls the blended WACC down below the pure equity cost.