Question

Video Excel Online Structured Activity: WACC and optimal capital budget Adamson Corporation is considering four average-risk projects with the following costs and rates of return: Project Cost 1 $2,000 3,000 5 ,000 2,000 Expected Rate of Return 16.00% 15.00 13.75 12.50 3 4 The company estimates that it can issue debt at a rate of rd = 11%, and its tax rate is 30%. 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 $35 per share; the next expected dividend, D1, is $3.25; 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. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below. Open spreadsheet 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 Project - Project d e Project co Check My Work Reset Problem

Answer 1

solution: after tax cost of debt (rd) =0.11*(1-0.3) cost of preferred stock = rp= Dividend/current price = 6/58 cost of retained earning = rs =(D1/PO) + g =(3.25/35) + 0.07 7.70% 10.34% 16.29% WACC=rd*wd+rp*wp+rs*ws WACC = 0.077 *0.15 + 0.1034*0.1+0.1629*0.75 14.40% Which projects should Adamson accept? Project accept as expected return is more than WACC. accept as expected return is more than WACC. reject as expected return is less than WACC. reject as expected return is less than WACC. 3