A firm has a capital structure containing 40% debt, 20% preferred stock, and 40% common stock equity. The firm’s debt has a yield to maturity of 8.1%, its preferred stock’s annual dividend is $3.10, and the preferred stock’s current market price is $50.00 per share. The firm’s common stock has a beta of 0.90, and the risk-free rate and the market return are currently 4.0% and 13.5%, respectively. The firm is subject to a 40% tax rate.
a. What is the firm’s cost of preferred stock?
b. What is the firm’s cost of common stock?
c. Calculate the firm’s after-tax WACC.
d. Recalculate the firm’s WACC, assuming that its capital structure is deleveraged to contain 20% debt, 20% preferred stock, and 60% common stock.
e. Compare, contrast, and discuss your findings from parts (c) and (d).