Final answer:
The correct term for the average of a firm's cost of equity and the after-tax cost of debt, weighted according to the firm's capital structure, is the Weighted Average Cost of Capital (WACC).
Step-by-step explanation:
The average of a firm's cost of equity and after-tax cost of debt that is weighted based on the firm's capital structure is called the Weighted Average Cost of Capital (WACC). This metric is essential for making investment decisions, as it represents the average rate of return that a company must earn on its existing assets to keep its shareholders and debt holders satisfied. A firm's WACC is often used to evaluate the economic feasibility of expansionary opportunities and mergers. While the cost of equity involves the expected rate of return that investors anticipate for their investment in the firm, the after-tax cost of debt refers to the actual rate of debt service the company owes, adjusted for the tax deductions that interest payments allow.
Considering the information about the cost of financial capital, interest rate risks, and the expected rate of return, the firm's investments and capital expenditures should always aim to exceed its WACC to create value for its shareholders. Therefore, when assessing potential projects, companies will generally undertake those that offer a return higher than this calculated weighted average cost.
To answer the original question, the correct option for the average of a firm's cost of equity and after-tax cost of debt, weighted by the firm's capital structure, is: a. Weighted Average Cost of Capital.