Adams Corporation is considering four average-risk projects with the following c
ID: 2738440 • Letter: A
Question
Adams Corporation is considering four average-risk projects with the following costs and rates of return:
The company estimates that it can issue debt at a rate of rd = 11%, and its tax rate is 35%. It can issue preferred stock that pays a constant dividend of $3 per year at $42 per share. Also, its common stock currently sells for $37 per share; the next expected dividend, D1, is $4.75; 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.
What is the cost of each of the capital components? Round your answers to two decimal places.
Cost of debt %
Cost of preferred stock %
Cost of retained earnings %
What is Adams' WACC? Round your answer to two decimal places.
%
Only projects with expected returns that exceed WACC will be accepted. Which projects should Adams accept?
Project Cost Expected Rate of Return 1 $2,000 16.00% 2 3,000 15.00 3 5,000 13.75 4 2,000 12.50Explanation / Answer
Cost of debt = 11%
Tax rate = 35%
11- 35% = 7.15%
Cost of preferred stock = $3/$42 = 7.14%
Cost of equity = ($4.75/$37) + 4% = 16.8%
WACC = 7.15 * ( 15/100) + 7.14 * (10/100) + 16.8 * (75/100)
= 1.0725 + 0.714 + 12.6
= 14.39%
Project 1, whose expected rate of return is 16% will be accepted...
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