Which component of WACC is typically tax-adjusted?

The after-tax cost of debt is typically tax-adjusted because interest payments on debt are tax-deductible, which reduces the effective cost of borrowing for a company. When calculating WACC (Weighted Average Cost of Capital), the after-tax cost of debt takes into account the tax shield provided by these deductions.

The formula for the after-tax cost of debt reflects the fact that a corporation pays less in taxes because it can deduct interest payments before calculating its taxable income. Thus, the after-tax cost of debt is calculated by multiplying the nominal cost of debt by (1 - tax rate). This adjustment is crucial because it provides a more accurate representation of the actual cost of debt to the firm, which, in turn, affects the overall WACC.

In contrast, the cost of equity, cost of capital from preferred stock, and cost of retained earnings do not involve similar tax adjustments because they do not provide tax benefits like interest on debt does. The cost of equity is the return required by equity investors, while the costs associated with preferred stock and retained earnings are also calculated based on required returns rather than taxable income. Thus, those components are directly used in the calculation of WACC without a tax adjustment.