Which sources of capital are typically included when calculating WACC?

When calculating the Weighted Average Cost of Capital (WACC), the primary components considered are the costs associated with debt and equity financing. WACC represents a firm's average rate of return that it is expected to pay its security holders to finance its assets.

Debt financing includes loans, bonds, and any other forms of borrowing that the company uses to fund its operations. The cost of debt is typically calculated after tax, as interest expenses on debt are tax-deductible, which reduces the overall cost to the firm.

Equity financing refers to funds raised by issuing common or preferred stock. The cost of equity is calculated based on the expected return required by equity investors, usually estimated using models such as the Capital Asset Pricing Model (CAPM).

Including only preferred stock or focusing solely on market capitalization would not provide a complete picture of the company's overall cost of capital. Additionally, cash and reserves are typically not considered part of the capital structure used to calculate WACC, as they represent assets rather than sources of financing.

Hence, debt and equity financing are essential components of the WACC calculation, making the correct choice the inclusion of these sources in the formula.