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Question 11.P.1: (a) The corporate tax rate is 0.35. Complete the following t...

(a) The corporate tax rate is 0.35. Complete the following table.

Required returns Before-tax costs Tax Tax savings After-Tax cost
Debt 0.12
Preferred stock 0.11
Common stock 0.14

(b) The after-tax weighted average cost of capital (0.45 debt, 0.15 preferred stock,
0.40 common stock) is

WACC =

(c) An investor buying a vertical slice of the firm will earn how large a return if
the required returns are earned?

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(a) The corporate tax rate is 0.35.

Required returns Before-tax costs Tax Tax savings After-Tax cost
Debt 0.12 0.12 0.042 0.078
Preferred stock 0.11 0.1692 0.0592 0.1100
Common stock 0.14 0.215 0.0754 0.1400

(b) The after-tax weighted average cost of capital (0.45 debt, 0.15 preferred stock, 0.40 common stock) is

WACC = 0.45(0.078) + 0.15(0.11) + 0.40(0.14) = 0.1075.

(c) An investor buying a vertical slice of the firm will earn a return of 0.1265 if the required returns are earned.

r = 0.45(0.12) + 0.15(0.11) + 0.40(0.14) = 0.1265.