Question

​AllCity, Inc., is financed 40 % with​ debt, 13% with preferred​ stock, and 47% with common stock. Its cost of debt is 6.3 %, its preferred stock pays an annual dividend of $2.51 and is priced at $ 25. It has an equity beta of 1.14. Assume the​ risk-free rate is 2.2%​, the market risk premium is 6.9 % 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

We know that the after tax WACC is given by the following formula,

WACC = (Cost of Equity*%equity) + (cost of debt*%debt*(1-tax rate)) + Cost of preferred stock*%preferred stock

Where

Cost of equity = Risk free rate + (beta*market risk premium)

Risk free rate = 2.2% = 0.022

Beta = 1.14

market risk premium = 6.9% = 0.069

Substituting these in the cost of equity formula, we get

Cost of equity = 0.022 + (1.14*0.069)

Cost of equity = 0.022 + 0.0787

Cost of equity = 0.1007

%equity = 47% = 0.47

Cost of debt = 6.3% = 0.063

%debt = 40% = 0.40

(1-tax rate) = 1-35% = 0.65

Cost of preferred stock = Annual dividend/ Stock price

Cost of preferred stock = 2.51/ 25

Cost of preferred stock = 0.1004

%preferred stock = 13% = 0.13

Substituting these in the WACC formula, we get

WACC = (0.1007*0.47) + (0.063*0.40*0.65) + 0.1004*0.13

WACC = (0.04731) + (0.01638) + (0.01305)

WACC = 0.0767

WACC = 7.67%

Therefore afetr tax wacc is 7.67%