5.Capital Co. has a capital structure, based on current market values, that consists of 21 percent debt, 9 percent preferred stock, and 70 percent common stock. If the returns required by investors are 10 percent, 12 percent, and 17 percent for the debt, preferred stock, and common stock, respectively, what is Capital’s after-tax WACC? Assume that the firm’s marginal tax rate is 40 percent. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

Question

5.Capital Co. has a capital structure, based on current market values, that consists of 21 percent debt, 9 percent preferred stock, and 70 percent common stock. If the returns required by investors are 10 percent, 12 percent, and 17 percent for the debt, preferred stock, and common stock, respectively, what is Capital’s after-tax WACC? Assume that the firm’s marginal tax rate is 40 percent. (Round intermediate calculations to 4 decimal places, e.g. 1.2514 and final answer to 2 decimal places, e.g. 15.25%.)

After tax WACC= %

Answer 1

To calculate the after-tax WACC (Weighted Average Cost of Capital), we need to follow these steps:

Step 1: Find the after-tax cost of each capital component.
Step 2: Calculate the weights of each capital component.
Step 3: Multiply the after-tax cost of each component by its weight.
Step 4: Sum up the weighted costs of each component to get the after-tax WACC.

Let's calculate each step:

Step 1: Find the After-Tax Cost of Each Capital Component

Debt:
Given: Return required by investors for debt = 10%
Since interest expense is tax-deductible, we need to calculate the after-tax cost.
After-tax cost of debt = Cost of debt * (1 - tax rate) = 10% * (1 - 0.40) = 6%

Preferred Stock:
Given: Return required by investors for preferred stock = 12%
Preferred stock dividends are not tax-deductible, so the after-tax cost is the same as the pre-tax cost.
After-tax cost of preferred stock = 12%

Common Stock:
Given: Return required by investors for common stock = 17%
Common stock dividends are not tax-deductible, so the after-tax cost is the same as the pre-tax cost.
After-tax cost of common stock = 17%

Step 2: Calculate the Weights of Each Capital Component

Given: Debt = 21%, Preferred stock = 9%, Common stock = 70%

Step 3: Multiply the After-Tax Cost of Each Component by Its Weight

Debt weight * After-tax cost of debt = 0.21 * 6% = 1.26%
Preferred stock weight * After-tax cost of preferred stock = 0.09 * 12% = 1.08%
Common stock weight * After-tax cost of common stock = 0.70 * 17% = 11.90%

Step 4: Sum Up the Weighted Costs of Each Component

After-tax WACC = Weighted cost of debt + Weighted cost of preferred stock + Weighted cost of common stock
= 1.26% + 1.08% + 11.90%
= 14.24%

Therefore, Capital's after-tax WACC is 14.24%.