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 Return 16.00% $2,000 3,000 15.00 5,000 13.75 2,000 12.50 The company estimates that it can issue debt at a rate of r-9%, and its tax rate is 40%. It can issue preferred stock that pays a constant dividend of $6 per year at $59 per share. Also, its common stock currently sells for $31 per share; the next expected dividend, Di, is $3.00; and the dividend is expected to grow at a constant rate of 7% 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 -Select- Project 3 Project 4

Answer 1

As calculated WACC is 14.337% and only those projects are to be selected whose expected return is > WACC Projects expected return Decission 16.00% > 14.337 accept 15.00% > 14,337 accept 13175% -14,337 reject 12.50% 2 14.337 reject EWNH so only Projects 1 & 2 are selected.
Answer to the following questions.
O calculation of cost of dubt (kd) given kd=9%, tax-40% lassume that it is before tow. so Kd = 9% (100% - 40%) Kd = 5.4% 2 calculation of cost of Preffered stock = [Dividend / price of stock.] x 100 = 16/59)x100 = 10:17% ③ cost of Retained earnings (equity) here ke = Dita As per info in the question dividend next yr = $3.0 I = growth rate = 7% & P = $ 31 per share so we have ke = 3 +7% 1/3 +0.07x100 ptg ike = 16.68% wack 4 computation of WALL components ratios calculation a) Dent 0.15 Kd= 0.15 x 5.4% b) common stock 0.75 0.758 16.68 0.10 X 10.17 Total 1.0 Ko 0.81 12.51 Stock 0110 10017 14.337