Question

Adamson Corporation is considering four average-risk projects with the following costs and rates of return: Project Cost Expected Rate of Return 16.00% 15.00 $2,000 3,000 5,000 2,000 13.75 12.50 The company estimates that it can issue debt at a rate of rd = 10%, and its tax rate is 25%. It can issue preferred stock that pays a constant dividend of $5.00 per year at $47.00 per share. Also, its common stock currently sells for $35.00 per share; the next expected dividend, D1, is $3.25; and the dividend is expected to grow at a constant rate of 7% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock. a. What is the cost of each of the capital components? Do not round intermediate calculations. Round your answers to two decimal places. Cost of debt: Cost of preferred stock: % Cost of retained earnings: b. What is Adamson's WACC? Do not round intermediate calculations. Round your answer to two decimal places. C. Only projects with expected returns that exceed WACC will be accepted. Which projects should Adamson accept? Project 1 Project 2 Project 3 Project 4 -Select- v -Select- -Select- -Select-

Answer 1

Cost of debt after tax = 10% x (1-0.25) = 7.50% cost of preferred stock = "5/47 10.64% Cost of equity,retained earnings D1/price + g = 16.29% (3.25/35) +0.07 Particulars common equity Preferred stock Debt capital structure weights 0.75 0.10 0.15 cost 16.29% 10.64% 7.50% weighted cost 0.122142857 0.010638298 0.01125 14.40% WACC 1 Project 1 Project 2 Project 3 Project 4 Accept Accept Reject Reject