Question

​AllCity, Inc., is financed 38% with​ debt, 13% with preferred​ stock, and 49% with common stock. Its cost of debt is 5.8%​, its preferred stock pays an annual dividend of $2.48 and is priced at $25. It has an equity beta of 1.1. Assume the​ risk-free rate is 1.9 %​, the market risk premium is 7.1% 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

Cost of equity

As per CAPM

Cost of equity = risk-free rate + beta * (Market risk premium)

Cost of equity% = 1.9 + 1.1 * (7.1)

Cost of equity% = 9.71

After tax cost of debt = cost of debt*(1-tax rate)

After tax cost of debt = 5.8*(1-0.35)

= 3.77

cost of preferred equity

cost of preferred equity = Preferred dividend/price*100

cost of preferred equity = 2.48/25*100

=9.92

Weight of equity = E/A

Weight of equity =

W(E)=0.49

Weight of debt = D/A

Weight of debt = 0.38

W(D)=0.38

Weight of preferred equity =1-D/A-E/A

Weight of preferred equity = =1-0.38 - 0.49

W(PE)=0.13

WACC=after tax cost of debt*W(D)+cost of equity*W(E)+Cost of preferred equity*W(PE)

WACC=3.77*0.38+9.71*0.49+9.92*0.13

WACC% = 7.48