WACC and optimal capital budget Adamson Corporation is considering four average-

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WACC and optimal capital budget

Adamson 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 = 9%, and its tax rate is 35%. It can issue preferred stock that pays a constant dividend of $6 per year at $58 per share. Also, its common stock currently sells for $30 per share; the next expected dividend, D1, is $3.25; and the dividend is expected to grow at a constant rate of 5% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock.

WACC and optimal capital budget

Adamson 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 = 9%, and its tax rate is 35%. It can issue preferred stock that pays a constant dividend of $6 per year at $58 per share. Also, its common stock currently sells for $30 per share; the next expected dividend, D1, is $3.25; and the dividend is expected to grow at a constant rate of 5% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock.

1. 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 %
   
2. What is Adamson's WACC? Round your answer to two decimal places. Do not round your intermediate calculations.
   %
   
3. Only projects with expected returns that exceed WACC will be accepted. Which projects should Adamson accept? Project 1 -Select-acceptrejectItem 5 Project 2 -Select-acceptrejectItem 6 Project 3 -Select-acceptrejectItem 7 Project 4 -Select-acceptreject
   
   Item 8

Explanation / Answer

cost of debt=9%
cost of preferre stock=Preferred dividend/Preferred stock price=6/58=10.3448%
cost of equity=D1/P0+g=3.25/30+5%=15.833%

WACC=75%*15.833%+15%*9%*(1-35%)+10%*10.3448%=13.7867%

Accept all projects whose expected rate of return is greater than WACC
Hence, Accept Project 1&2

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