Frequently Asked Questions

Students have asked why in certain situations, the following formula is used to calculate the Cost of Equity (Re) = Ra + D/E (Ra - Rd), while ignoring the tax implications on the cost of equity (1-T). The answer is that when the D/E ratio is constant, we should assume that the Beta of the ITS is equal to the beta of A and therefore the following proposition holds: Re = Ra + D/E (Ra - Rd).

On the other hand, when we assume beta of ITS is equal to beta of D, then proposition II is Re = Ra + D/E (Ra - Rd) (1-t).

However, the calculation of the WACC should always take into account the tax rate, and hence be the after tax WACC.

Further details can be found in slides 44-47 of the video lectures.