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Why is the after-tax cost of debt used in WACC?

  1. A Interest is tax deductible, so the effective cost to the firm is reduced
  2. B Debt is riskier than equity
  3. C It simplifies the calculation
  4. D Regulators require it
Answer

Interest is tax deductible, so the effective cost to the firm is reduced

This tax shield is the primary source of value creation from leverage in the Modigliani-Miller framework with taxes.

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