Should the component costs be figured on a before-tax or an after-tax basis?

Solution:
On an after-tax basis. The main concern of stockholders is whether the company’s cash flows
are available for them to use, which also entails whether the cash flows are used to pay
dividends or reinvest. Because dividends are paid and reinvestment is made with after-tax
cash, the component costs should be calculated on an after-tax basis. After-tax cash flow and
rate of return calculations should be performed.
We use the after-tax cost of debt in the calculation of WACC because we want to maximize
the value of the firm’s shares, which is based on after-tax cash flows rather than before-tax
cash flows. As a result of the advantageous tax treatment of debt, we lower the interest rate.

1 By: Syed Jawad Ali Kazmi