The correct answer is: C. Tax factor is ignored.
Weighted average cost of capital (WACC) is a measure of a company’s cost of capital, which is used to evaluate the profitability of new projects. WACC is calculated by taking the weighted average of the costs of different sources of capital, such as debt, equity, and preferred stock.
The cost of debt is the interest rate that a company pays on its loans. The cost of equity is the return that shareholders expect to earn on their investment in the company. The cost of preferred stock is the dividend that a company pays on its preferred stock.
The weights in WACC are determined by the relative proportions of each type of capital that a company uses. For example, if a company has $100 million in debt, $50 million in equity, and $25 million in preferred stock, the weights would be 0.5, 0.25, and 0.25, respectively.
The tax factor is not included in WACC because interest payments on debt are tax-deductible. This means that the cost of debt is actually lower than the stated interest rate, because the company gets a tax break for paying interest.
The risk factor is included in WACC because investors demand a higher return for riskier investments. The higher the risk, the higher the cost of capital.
Here is a brief explanation of each option:
- Option A: Preference shares are given more weight age. This is not true. The weights in WACC are determined by the relative proportions of each type of capital that a company uses.
- Option B: Cost of issue is considered. This is not true. The cost of issue is not included in WACC because it is a one-time expense.
- Option C: Tax factor is ignored. This is true. The tax factor is not included in WACC because interest payments on debt are tax-deductible.
- Option D: Risk factor is ignored. This is not true. The risk factor is included in WACC because investors demand a higher return for riskier investments.