Question

Any help would be appreciated - thanks! :)

Adamson Corporation is considering four average-risk projects with the following costs and rates of return: Project Expected Rate of Return Cost $2,000 3,000 16.00% 2 15.00 3 5,000 13.75 2,000 12.50 The company estimates that it can issue debt at a rate of ra = 11%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $6 per year at $56 per share. Also, its common stock currently sells for $37 per share; the next expected dividend, D1, is $4.25; and the dividend is expected to grow at a constant rate of 4% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below. Open spreadsheet a. What is the cost of each of the capital components? Round your answers to two decimal places. Do not round your intermediate calculations. Cost of debt Cost of preferred stock % Cost of retained earnings % b. What is Adamson's WACC? Round your answer to two decimal places. Do not round your intermediate calculations. 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

Answer 1

a. Cost of debt =11%
Cost of Preferred Shares =Dividend/Price =6/56 =10.71429% or 10.71%
Cost of Retained Earnings =D1/Price+growth =4.25/37+4% =15.4865% or 15.49%

b. WACC
=Weight of common stock*Cost of equity+Weight of Preferred Stock*Cost of Preferred Stock+Weight of Debt*Cost of Debt*(1-tax Rate) =75%*15.4865%+10%*10.71429%+15%*11%*(1-30%) =13.84%

c. Project 1 should be accepted as WACC will be higher.
Project 2 should be accepted
Project 3 should be rejected
Project 4 should be rejected.