Capital Co. has a capital structure, based on current market values, that consists of 50 percent debt, 10 percent preferred stock, and 40 percent common stock. If the returns required by investors are 8 percent, 10 percent, and 15 percent for the debt, preferred stock, and common stock, respectively, what is Capital’s after-tax WACC?

In order to calculate Capital Co.’s after-tax WACC (weighted average cost of capital) we must first determine the required return for each type of financing and then apply relevant tax rates. As debt is typically cheaper than equity, the expected return for this type of financing should be at least 8 percent. Next in line is preferred stock at 10%, and common stock with a return of 15%.

Then, these returns need to be adjusted for taxes. Since interest paid on debts is tax-deductible but dividends are not. Debt can therefore only partially shield you from taxes. The after-tax costs associated with debt, equity and dividends would then be 6.5%, 7.5% and 11.25 % respectively.

Finally, to arrive at an overall WACC we simply multiply each respective after-tax cost by its weighting within Capital Co’s capital structure (i.e., 50% x 6%, 10% x 7.5%, 40% x 11.25%) – which in this case works out to be 5%. This figure represents the company’s estimated weighted average cost of capital after accounting for applicable taxes; it can then be used for comparison against actual returns realized from investments or other projects undertaken by the organization so as to assess their economic performance over time.