Question

​AllCity, Inc., is financed

42 %

with​ debt,

5 %

with preferred​ stock, and

53 %

with common stock. Its cost of debt is

5.6 %,

its preferred stock pays an annual dividend of

$ 2.47

and is priced at

$ 25

It has an equity beta of

1.17

Assume the​ risk-free rate is

2 %

the market risk premium is

6.7 %

and​ AllCity's tax rate is

35 %

What is its​ after-tax WACC?

​Note: Assume that the firm will always be able to utilize its full interest tax shield.

Answer 1

Answer :

Calculation of After-tax WACC :

Cost of debt ( Kd ) = Pre-tax cost of debt * ( 1 - tax rate )

= 5.6 * ( 1 - 0.35 ) = 3.64%

Cost of preferred stock ( Kp ) = Preferred dividend / price

= 2.47 / 25 = 0.0988 = 9.88%

Cost of equity ( Ke ) ( as per CAPM ) = Risk-free rate + Beta * Market risk premium

= 2 + 1.17 * 6.7 = 9.839%

Now,

WACC = Kd * Wd + Kp * Wp + Ke * We

Where,

Wd, Wp and We are the weights of debt, preferred stock and equity.

Therefore,

WACC = 3.64 * 0.42 + 9.88 * 0.05 + 9.839 * 0.53

= 1.53 + 0.50 + 5.21

WACC = 7.24%