Question

AllCity Inc. is financed ​35% with​ debt, ​10% with preferred​ stock, and 55​% with common stock. Its​ pre-tax cost of debt is ​6%; its preferred stock pays an annual dividend of2.75 ​$ and is priced at 27​$. It has an equity beta of 1.3. Assume the​ risk-free rate is ​2%, the market risk premium is ​6%, and​ AllCity's tax rate is35 ​%. What is its​ after-tax WACC?

Answer 1

AllCity Inc.'s after-tax WACC is calculated using the weights of debt, preferred stock, and common equity along with their respective costs, leading to an after-tax WACC of 7.465%.

Step-by-step explanation:

To calculate AllCity Inc.'s after-tax Weighted Average Cost of Capital (WACC), we must consider the costs associated with each component of its capital structure. We use the weights of debt, preferred stock, and common equity along with their respective costs, adjusted where necessary, such as for the after-tax cost of debt.

The after-tax cost of debt is 6% * (1 - 0.35) = 3.9%. Then, we can use the given weights to calculate the weighted cost for each component. The cost of preferred stock is the dividend divided by the price, or $2.75 / $27 = 10.19%. The cost of common equity can be calculated using the Capital Asset Pricing Model (CAPM), which gives us a cost of 2% + 1.3 * 6% = 9.8%.

Combining these results:

Cost of debt (after-tax) weight: 0.35 * 3.9%

Cost of preferred stock weight: 0.10 * 10.19%

Cost of common equity weight: 0.55 * 9.8%

WACC = (0.35 * 3.9%) + (0.10 * 10.19%) + (0.55 * 9.8%) = 7.465%

Therefore, AllCity Inc.'s after-tax WACC is 7.465%.