Question

​AllCity, Inc., is financed 39 % with​ debt, 11 % with preferred​ stock, and 50 % with common stock. Its cost of debt is 6.1 %​, its preferred stock pays an annual dividend of $ 2.53 and is priced at $ 33. It has an equity beta of 1.11. Assume the​ risk-free rate is 2.2 %​, the market risk premium is 6.7 % and​ AllCity's tax rate is 35 %. What is its​ after-tax WACC?

Answer 1

Answer:

Cost of debt (Kd) = 6.1%

Cost of preferred stock = Dividend paid

                                        Current market price

                                      = $2.53

                                         $33

                                      = 0.0767 = 7.67%

Risk-free rate (Rf) = 2.2%

Beta (β) = 1.11

Market risk premium (Rm - Rf) = 6.7%

Cost of equity (Ke) = Rf +β(Rm - Rf)

Cost of equity (Ke) = 2.2 + 1.11(6.7)

Cost of equity (Ke) =  9.637%    

WACC = Kd(D/V)(1-T) + Kp(P/V) + Ke(E/v)

WACC = 6.1(39  /100)(1 -0.35) + 7.67(11/100) + 9.637(50/100)  

WACC  = 1.55 + 0.84 + 4.82  

WACC  = 7.21%                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

Explanation:

In this case, cost of debt has been given. Cost of preferred stock is calculated as current dividend paid divided by current market price.

Cost of equity is calculated based on capital asset pricing model, which is Risk-free rate plus beta multiplied by the market risk premium.

WACC equals after-tax cost of debt multiplied by the proportion of debt in the capital structure plus cost of preferred stock multiplied by the proportion of preferred stock in the capital structure plus cost of equity multiplied by proportion of equity in the capital structure.