Breaking Into Wall Street 400 Practice Test

What is the correct formula for WACC?

(cost of debt * debt) / (debt + equity) + (cost of equity * equity) / (debt + equity) (cost of debt * debt * (1 - tax rate)) / (debt + equity) + (cost of equity * equity) / (debt + equity) (cost of debt * debt) / (debt - equity) + (cost of equity * equity) / (debt - equity) (cost of debt + cost of equity) / 2

Correct Answer:

(cost of debt * debt * (1 - tax rate)) / (debt + equity) + (cost of equity * equity) / (debt + equity)

Explanation:

WACC represents the blended cost of financing a company uses, combining the after‑tax cost of debt with the cost of equity and weighting each by how much of the capital structure comes from debt and from equity. The debt portion is taxed-deductible, so its true cost is Rd × (1 − Tc). The weights are the proportions of debt and equity in the total capital, D/(D+E) and E/(D+E). Put together, the formula is: [Rd × D × (1 − Tc) + Re × E] / (D + E). This expands to (Rd × D × (1 − Tc))/(D+E) + (Re × E)/(D+E), which matches the correct expression. The other forms either omit the tax shield on debt, use an incorrect denominator like (D − E), or simply average the two costs without proper weighting.

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