WACC AND OPTIMAL CAPITAL BUDGET Adamson Corporation is considering four average-

ID: 2791201 • Letter: W

Question

WACC AND OPTIMAL CAPITAL BUDGET Adamson Corporation is considering four average-risk projects with the following costs and rates of return: Project Cost Expected Rate of $2,000 3,000 5,000 2,000 Return 16.00% 15.00 13.75 12.50 The company estimates that it can issue debt at a rate of rd = 10%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $3 per year at $58 per share. Also, its common stock currently sells for $40 per share; the next expected dividend, D1, is $4.50; and the dividend is expected to grow at a constant rate of 6% 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? 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 Select- Select- Select-

Explanation / Answer

Cost of preferred stock = Kp/Market price

= 3/58 =5.17%

cost of common stock/retained earning

= (D1/P0) + G

= 4.5/40 +6%

=17.25%

Project 1 yes

Project 2 Yes

Project 3 NO

Project 4 NO

cost of debt = KD (1-tax) =10%*(1-0.3) =7.00%