Problem 10-18 WACC and optimal capital budget Adamson Corporation is considering

Question

Problem 10-18 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 1096, and its tax rate is 40% It can issue preferred stock that pays a constant dividend of S4 per year at $45 per share. Also, its common stock currently sells for S37 per share; the next expected dividend. D1, is S4.25; and the dividend is expected to grow at a constant rate of 6% per year. The target capital structure consists of 7596 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 carnings What is Adamson's WACC? Round b. your answer to two decimal places. Do not round your 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- -Select

Explanation / Answer

Question - a

Cost of debt = 10% ( 1 - tax rate ) = 10% ( 1 - 0.40) = 6% ......... final answer

Cost of preferred stock = Dividend / Sale value * 100 = 4 / 45 * 100 = 8.89 % ........ final answer

Cost of Retained earnings = Expected dividend / Sale value * 100 + growth rate

= 4.25 / 37 * 100 + 6 = 17.49 % ........... final answer

Question - b

WACC = 14.90 ...............Final answer

Question - c

Projects with expected return less than WACC cannot be accepted.

K W KW Debt 6 0.15 0.9 Preferred stock 8.888889 0.1 0.8888889 Retained / Equity 17.48649 0.75 13.114865 WACC = 14.90

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