{"id":30386,"date":"2022-10-25T06:46:10","date_gmt":"2022-10-25T06:46:10","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=30386"},"modified":"2026-03-05T19:18:19","modified_gmt":"2026-03-05T19:18:19","slug":"effect-of-taxes-on-cost-of-capital","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/","title":{"rendered":"Effect of Taxes on Cost of Capital"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"VideoObject\",\n  \"name\": \"Cost of Capital \u2013 Fundamental Topics (2025 CFA\u00ae Level I \u2013 Corporate Issuers\u2013Module 6)\",\n  \"description\": \"This video lesson covers the weighted average cost of capital (WACC) and its components. It teaches how to calculate WACC, assess tax effects on capital costs, compute costs of debt, preferred stock, and equity using various models, estimate beta for different companies, and correctly account for flotation costs in capital budgeting.\",\n  \"uploadDate\": \"2021-10-17T00:00:00+00:00\",\n  \"thumbnailUrl\": \"https:\/\/i.ytimg.com\/vi\/HkoJ_nedolg\/hqdefault.jpg\",\n  \"contentUrl\": \"https:\/\/www.youtube.com\/watch?v=HkoJ_nedolg\",\n  \"embedUrl\": \"https:\/\/www.youtube.com\/embed\/HkoJ_nedolg\",\n  \"duration\": \"PT40M28S\"\n}\n<\/script>\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"Which source of capital is most likely affected by taxes?\",\n    \"text\": \"Which of the following sources of capital do taxes most likely affect?\\n\\nA. Debt.\\n\\nB. Preferred stock.\\n\\nC. Common equity.\",\n    \"answerCount\": 1,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"The correct answer is A. Taxes affect the cost of debt because interest payments are tax-deductible, resulting in an after-tax cost of debt that is lower than the before-tax cost. Taxes generally do not directly affect the cost of common equity or preferred stock.\"\n    }\n  }\n}\n<\/script>\n\n\n\n<p>\n  <iframe loading=\"lazy\"\n    src=\"\/\/www.youtube.com\/embed\/HkoJ_nedolg\"\n    width=\"611\"\n    height=\"343\"\n    allowfullscreen=\"allowfullscreen\">\n  <\/iframe>\n<\/p>\n\n\n<p>Taxes significantly impact the weighted average cost of capital (WACC) of a company. However, taxes affect the cost of capital from different sources of capital in different ways.<\/p>\n<p><a style=\"display: block; margin: 24px 0 30px; padding: 14px 20px; border: 2px solid #2563eb; border-radius: 14px; text-align: center; color: #2563eb; text-decoration: none; font-weight: 500; font-size: 15px; background-color: #ffffff;\" href=\"https:\/\/analystprep.com\/free-trial\/\" target=\"_blank\" rel=\"noopener noreferrer\"> Practice WACC and tax shield questions in a free trial. <\/a><\/p>\n<h2><strong>The Effect of Taxes on Debt<\/strong><\/h2>\n<p>In many tax jurisdictions, interest on debt financing is a deduction made before arriving at a company&#8217;s taxable income. You may recall that in the equation used to compute the WACC of a company, the expected before-tax cost on new debt financing, <em>r<sub>d<\/sub><\/em>, is adjusted by a factor, (1-t). Multiplying <em>r<sub>d<\/sub><\/em>, by the factor (1-t), results in an estimate of a company\u2019s after-tax cost of debt.<\/p>\n<p>An example will help to explain this concept better. If, for example, company XYZ pays $10,000 as interest expense on a\u00a0 $100,000 debt to bondholders, and the company is subject to a tax rate of 35%, then the cost of debt would be ($10,000) \u00d7 (1 &#8211; 0.35) = $6,500. The cost of debt would not be the entire $10,000 that is paid as interest expense. The reason for this is that a company&#8217;s taxable income would be reduced by $10,000, which leads to a reduction in the amount of tax that the company pays by ($10,000) \u00d7 35% = $3,500. The before-tax cost of debt for the company would be ($10,000\/$100,000) = 10%, while the after-tax cost of debt would be ($6,500\/$100,000) = 6.5%.<\/p>\n<h2><strong>The Effect of Taxes on Common Equity and Preferred Stock<\/strong><\/h2>\n<p>Taxes do not affect the cost of common equity or the cost of preferred stock. This is the case because the payments to the owners of these sources of capital, whether in the form of dividend payments or return on capital, are not tax-deductible for a company. This explains why in the equation for computing the WACC of a company, no tax adjustment is made for these sources of capital.<\/p>\n<blockquote>\n<h2><strong>Question<\/strong><\/h2>\n<p>Which of the following sources of capital do taxes <em>most likely<\/em> affect?<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li>Debt.<\/li>\n<li>Preferred stock.<\/li>\n<li>Common equity.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>A<\/strong>.<\/p>\n<p>A company\u2019s before-tax cost of debt is adjusted for taxes to derive the after-tax cost of debt for the company.<\/p>\n<p><strong>A and B are incorrect<\/strong> because taxes do not affect the cost of common equity or the cost of preferred stock.<\/p>\n<\/blockquote>\n\n\n<div style=\"text-align:center;margin:50px 0 30px;\">\n\n  <a href=\"https:\/\/analystprep.com\/free-trial\/\"\n     target=\"_blank\"\n     rel=\"noopener noreferrer\"\n     style=\"\n       display:inline-block;\n       padding:14px 34px;\n       background:linear-gradient(135deg,#4a74d1,#3b66c4);\n       color:#ffffff;\n       font-size:18px;\n       font-weight:600;\n       text-decoration:none;\n       border-radius:50px;\n       box-shadow:0 6px 18px rgba(59,102,196,0.25);\n     \">\n     Start Free Trial\n  <\/a>\n\n  <p style=\"\n       margin:18px auto 0;\n       max-width:620px;\n       font-size:16px;\n       line-height:1.6;\n       color:#333333;\n     \">\n     Build confidence in after-tax cost of debt and the tax shield effect with CFA Level I exam-style practice questions.\n  <\/p>\n\n<\/div>\n","protected":false},"excerpt":{"rendered":"<p>Taxes significantly impact the weighted average cost of capital (WACC) of a company. However, taxes affect the cost of capital from different sources of capital in different ways. Practice WACC and tax shield questions in a free trial. The Effect&#8230;<\/p>\n","protected":false},"author":10,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[25],"tags":[],"class_list":["post-30386","post","type-post","status-publish","format-standard","hentry","category-corporate-issuers","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Taxes &amp; Cost of Capital Impact | CFA Level 1 - AnalystPrep<\/title>\n<meta name=\"description\" content=\"Learn how taxes influence a company\u2019s weighted average cost of capital (WACC) and affect the cost of debt and equity financing.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Taxes &amp; Cost of Capital Impact | CFA Level 1 - AnalystPrep\" \/>\n<meta property=\"og:description\" content=\"Learn how taxes influence a company\u2019s weighted average cost of capital (WACC) and affect the cost of debt and equity financing.\" \/>\n<meta property=\"og:url\" content=\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/\" \/>\n<meta property=\"og:site_name\" content=\"AnalystPrep | CFA\u00ae Exam Study Notes\" \/>\n<meta property=\"article:published_time\" content=\"2022-10-25T06:46:10+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2026-03-05T19:18:19+00:00\" \/>\n<meta name=\"author\" content=\"AnalystPrep Team\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:label1\" content=\"Written by\" \/>\n\t<meta name=\"twitter:data1\" content=\"AnalystPrep Team\" \/>\n\t<meta name=\"twitter:label2\" content=\"Est. reading time\" \/>\n\t<meta name=\"twitter:data2\" content=\"2 minutes\" \/>\n<script type=\"application\/ld+json\" class=\"yoast-schema-graph\">{\"@context\":\"https:\/\/schema.org\",\"@graph\":[{\"@type\":\"Article\",\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/#article\",\"isPartOf\":{\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/\"},\"author\":{\"name\":\"AnalystPrep Team\",\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/#\/schema\/person\/abf579052a9beb34ebf7d292e3967ce8\"},\"headline\":\"Effect of Taxes on Cost of Capital\",\"datePublished\":\"2022-10-25T06:46:10+00:00\",\"dateModified\":\"2026-03-05T19:18:19+00:00\",\"mainEntityOfPage\":{\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/\"},\"wordCount\":391,\"articleSection\":[\"Corporate Issuers\"],\"inLanguage\":\"en-US\"},{\"@type\":\"WebPage\",\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/\",\"url\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/\",\"name\":\"Taxes & Cost of Capital Impact | CFA Level 1 - AnalystPrep\",\"isPartOf\":{\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/#website\"},\"datePublished\":\"2022-10-25T06:46:10+00:00\",\"dateModified\":\"2026-03-05T19:18:19+00:00\",\"author\":{\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/#\/schema\/person\/abf579052a9beb34ebf7d292e3967ce8\"},\"description\":\"Learn how taxes influence a company\u2019s weighted average cost of capital (WACC) and affect the cost of debt and equity financing.\",\"breadcrumb\":{\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/#breadcrumb\"},\"inLanguage\":\"en-US\",\"potentialAction\":[{\"@type\":\"ReadAction\",\"target\":[\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/\"]}]},{\"@type\":\"BreadcrumbList\",\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/#breadcrumb\",\"itemListElement\":[{\"@type\":\"ListItem\",\"position\":1,\"name\":\"Home\",\"item\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/\"},{\"@type\":\"ListItem\",\"position\":2,\"name\":\"Effect of Taxes on Cost of Capital\"}]},{\"@type\":\"WebSite\",\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/#website\",\"url\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/\",\"name\":\"AnalystPrep | CFA\u00ae Exam Study Notes\",\"description\":\"\",\"potentialAction\":[{\"@type\":\"SearchAction\",\"target\":{\"@type\":\"EntryPoint\",\"urlTemplate\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/?s={search_term_string}\"},\"query-input\":{\"@type\":\"PropertyValueSpecification\",\"valueRequired\":true,\"valueName\":\"search_term_string\"}}],\"inLanguage\":\"en-US\"},{\"@type\":\"Person\",\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/#\/schema\/person\/abf579052a9beb34ebf7d292e3967ce8\",\"name\":\"AnalystPrep Team\",\"image\":{\"@type\":\"ImageObject\",\"inLanguage\":\"en-US\",\"@id\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/#\/schema\/person\/image\/\",\"url\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-content\/uploads\/2018\/11\/myAvatar-5-150x150.png\",\"contentUrl\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-content\/uploads\/2018\/11\/myAvatar-5-150x150.png\",\"caption\":\"AnalystPrep Team\"},\"url\":\"https:\/\/analystprep.com\/cfa-level-1-exam\/author\/analystprep-team\/\"}]}<\/script>\n<meta property=\"og:video\" content=\"https:\/\/www.youtube.com\/embed\/HkoJ_nedolg\" \/>\n<meta property=\"og:video:type\" content=\"text\/html\" \/>\n<meta property=\"og:video:duration\" content=\"2429\" \/>\n<meta property=\"og:video:width\" content=\"480\" \/>\n<meta property=\"og:video:height\" content=\"270\" \/>\n<meta property=\"ya:ovs:adult\" content=\"false\" \/>\n<meta property=\"ya:ovs:upload_date\" content=\"2022-10-25T06:46:10+00:00\" \/>\n<meta property=\"ya:ovs:allow_embed\" content=\"true\" \/>\n<!-- \/ Yoast SEO plugin. -->","yoast_head_json":{"title":"Taxes & Cost of Capital Impact | CFA Level 1 - AnalystPrep","description":"Learn how taxes influence a company\u2019s weighted average cost of capital (WACC) and affect the cost of debt and equity financing.","robots":{"index":"index","follow":"follow","max-snippet":"max-snippet:-1","max-image-preview":"max-image-preview:large","max-video-preview":"max-video-preview:-1"},"canonical":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/","og_locale":"en_US","og_type":"article","og_title":"Taxes & Cost of Capital Impact | CFA Level 1 - AnalystPrep","og_description":"Learn how taxes influence a company\u2019s weighted average cost of capital (WACC) and affect the cost of debt and equity financing.","og_url":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/","og_site_name":"AnalystPrep | CFA\u00ae Exam Study Notes","article_published_time":"2022-10-25T06:46:10+00:00","article_modified_time":"2026-03-05T19:18:19+00:00","author":"AnalystPrep Team","twitter_card":"summary_large_image","twitter_misc":{"Written by":"AnalystPrep Team","Est. reading time":"2 minutes"},"schema":{"@context":"https:\/\/schema.org","@graph":[{"@type":"Article","@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/#article","isPartOf":{"@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/"},"author":{"name":"AnalystPrep Team","@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/#\/schema\/person\/abf579052a9beb34ebf7d292e3967ce8"},"headline":"Effect of Taxes on Cost of Capital","datePublished":"2022-10-25T06:46:10+00:00","dateModified":"2026-03-05T19:18:19+00:00","mainEntityOfPage":{"@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/"},"wordCount":391,"articleSection":["Corporate Issuers"],"inLanguage":"en-US"},{"@type":"WebPage","@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/","url":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/","name":"Taxes & Cost of Capital Impact | CFA Level 1 - AnalystPrep","isPartOf":{"@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/#website"},"datePublished":"2022-10-25T06:46:10+00:00","dateModified":"2026-03-05T19:18:19+00:00","author":{"@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/#\/schema\/person\/abf579052a9beb34ebf7d292e3967ce8"},"description":"Learn how taxes influence a company\u2019s weighted average cost of capital (WACC) and affect the cost of debt and equity financing.","breadcrumb":{"@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/#breadcrumb"},"inLanguage":"en-US","potentialAction":[{"@type":"ReadAction","target":["https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/"]}]},{"@type":"BreadcrumbList","@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-issuers\/effect-of-taxes-on-cost-of-capital\/#breadcrumb","itemListElement":[{"@type":"ListItem","position":1,"name":"Home","item":"https:\/\/analystprep.com\/cfa-level-1-exam\/"},{"@type":"ListItem","position":2,"name":"Effect of Taxes on Cost of Capital"}]},{"@type":"WebSite","@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/#website","url":"https:\/\/analystprep.com\/cfa-level-1-exam\/","name":"AnalystPrep | CFA\u00ae Exam Study Notes","description":"","potentialAction":[{"@type":"SearchAction","target":{"@type":"EntryPoint","urlTemplate":"https:\/\/analystprep.com\/cfa-level-1-exam\/?s={search_term_string}"},"query-input":{"@type":"PropertyValueSpecification","valueRequired":true,"valueName":"search_term_string"}}],"inLanguage":"en-US"},{"@type":"Person","@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/#\/schema\/person\/abf579052a9beb34ebf7d292e3967ce8","name":"AnalystPrep Team","image":{"@type":"ImageObject","inLanguage":"en-US","@id":"https:\/\/analystprep.com\/cfa-level-1-exam\/#\/schema\/person\/image\/","url":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-content\/uploads\/2018\/11\/myAvatar-5-150x150.png","contentUrl":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-content\/uploads\/2018\/11\/myAvatar-5-150x150.png","caption":"AnalystPrep Team"},"url":"https:\/\/analystprep.com\/cfa-level-1-exam\/author\/analystprep-team\/"}]},"og_video":"https:\/\/www.youtube.com\/embed\/HkoJ_nedolg","og_video_type":"text\/html","og_video_duration":"2429","og_video_width":"480","og_video_height":"270","ya_ovs_adult":"false","ya_ovs_upload_date":"2022-10-25T06:46:10+00:00","ya_ovs_allow_embed":"true"},"_links":{"self":[{"href":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-json\/wp\/v2\/posts\/30386","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-json\/wp\/v2\/users\/10"}],"replies":[{"embeddable":true,"href":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-json\/wp\/v2\/comments?post=30386"}],"version-history":[{"count":17,"href":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-json\/wp\/v2\/posts\/30386\/revisions"}],"predecessor-version":[{"id":59403,"href":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-json\/wp\/v2\/posts\/30386\/revisions\/59403"}],"wp:attachment":[{"href":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-json\/wp\/v2\/media?parent=30386"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-json\/wp\/v2\/categories?post=30386"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/analystprep.com\/cfa-level-1-exam\/wp-json\/wp\/v2\/tags?post=30386"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}