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CA Intermediate · Financial Management and Strategic Management · Cost of Capital

Which of the following is the correct description of the 'weighted average cost of capital' (WACC) of a firm?

WACC is the overall cost of capital obtained by weighting the specific cost of each source of finance, such as equity, preference shares and debt, by its proportion in the total capital structure, and then summing the weighted costs.

  1. AThe average of the cost of equity and the cost of debt, taken with equal weights
  2. BThe cost of the most recently raised source of finance
  3. CThe overall cost of capital computed by weighting the cost of each source of finance by its proportion in the total capital structureCorrect
  4. DThe cost of equity capital adjusted for the tax shield on interest

Explanation

WACC multiplies the cost of each source (equity, preference, debt, retained earnings) by its proportion in total capital and adds the results. Option A is wrong because it ignores the actual proportions of each source. Option B describes the marginal cost of the latest source, not the weighted average.

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