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When one uses the after-tax weighted average cost of capital (WACC) to value a levered firm, the interest tax shield is A) not accounted for by the use of the WACC. B) considered by deducting the interest payment from the cash flows. C) automatically considered because the after-tax cost of debt is included within the WACC formula. D) capitalized by the levered cost of equity.

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Answer:  C) automatically considered because the after-tax cost of debt is included within the WACC formula.

Explanation:

When calculating the Weighted Average Cost of Capital (WACC) for a levered firm, the interest tax shield is included because the cost of debt used is adjusted for tax as shown below:

= (Weight of debt * Cost of debt( 1 - tax rate) ) + (Weight of equity * cost of equity)

As shown above, the interest tax shield is already implicit in the formula so there is no need to adjust the levered firm for an interest tax shield as this would lead to double-counting.

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