Question

Adamson Corporation is considering four average-risk projects with the following costs and rates of return:

Project	Cost		Expected Rate of Return
1	$2,000		16.00%
2	3,000		15.00
3	5,000		13.75
4	2,000		12.50

The company estimates that it can issue debt at a rate of r_d = 11%, and its tax rate is 25%. It can issue preferred stock that pays a constant dividend of $6.00 per year at $57.00 per share. Also, its common stock currently sells for $45.00 per share; the next expected dividend, D₁, is $4.25; 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.

1. What is the cost of each of the capital components? Do not round intermediate calculations. Round your answers to two decimal places.

   Cost of debt:   %

   Cost of preferred stock:   %

   Cost of retained earnings:   %

2. What is Adamson's WACC? Do not round intermediate calculations. Round your answer to two decimal places.

     %

3. Only projects with expected returns that exceed WACC will be accepted. Which projects should Adamson accept?

   Project 1	-Select-Accept or Reject
   Project 2	-Select-Accept or Reject
   Project 3	-Select-Accept or Reject
   Project 4	-Select-Accept or Reject

Answer 1

solution: after tax cost of debt (rd) =0.11*(1-0.25) cost of preferred stock rp= Dividend/current price 6/57 Cost of retained earning rs (D1/PO)g =(4.25/45) + 0.06 8.25% 10.53% 15.44% WACC=rd*wd+rp*wp+rs*ws WACC 0.0825 *0.15 0.1053*0.1+0.1544*0.75 13.87% Which projects should Adamson accept? Project 1 2 accept as expected return is more than WACC. |accept as expected return is more than WACC reject reject as expected return is less than WACC 4 as expected return is less than WACC.