ACCA Financial Management (F9) Certification Practice Exam

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What is the interpretation of the variable 'T' in the weighted average cost of capital formula?

Tax rate
Time period
Debt capital
Earnings yield

The correct answer is: Tax rate

In the weighted average cost of capital (WACC) formula, the variable 'T' represents the tax rate. This is significant because WACC is used to determine a firm's cost of capital by calculating the average rate it must pay to finance its assets, taking into account the proportion of debt and equity in its capital structure. The inclusion of the tax rate is critical because interest payments on debt are tax-deductible. This tax shield effect reduces the effective cost of debt for the company. By incorporating 'T' into the formula, businesses can reflect the lower cost of capital associated with debt financing after accounting for taxes. Therefore, understanding how taxes impact WACC is essential for financial decision-making and evaluating the overall cost structure of a company. The other options do not fit in the context of WACC; specifically, time period does not apply as WACC is not dependent on a specific time dimension, debt capital could be referenced in terms of its weighting within the WACC calculation, but it is not represented by 'T,' and earnings yield relates to equity and does not pertain to the structure of WACC.