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 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 rd = 9%, and its tax rate is 35%. It can issue preferred stock that pays a constant dividend of $4 per year at $60 per share. Also, its common stock currently sells for $31 per share; the next expected dividend, D1, 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. 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 % What is Adamson's WACC? Round your answer to two decimal places. Do not round your intermediate calculations. % Only projects with expected returns that exceed WACC will be accepted. Which projects should Adamson accept? Project 1 Project 2 Project 3 Project 4
Cost of debt = 9%
Cost of Preferred Stock = Preferred Dividend / Current Price = $4 / $60 = 0.0667, or 6.67%
Cost of Retained Earnings = [D1 / P0] + g
= [$3 / $31] + 0.07 = 0.0968 + 0.07 = 0.1668, or 16.68%
WACC = [wD * kD * (1 - t)] + [wP * kP] + [wE * kE]
= [0.15 * 9% * (1 - 0.35)] + [0.10 * 6.67%] + [0.75 * 16.68%]
= 0.88% + 0.67% + 12.51% = 14.05%
Only Project 1 and 2 should be accepted as its Expected Return is more than WACC.
WACC and optimal capital budget Adamson Corporation is considering four average-risk projects with the following costs...
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 $2,000 16.00% 3,000 15.00 5,000 13.75 2,000 12.50 The company estimates that it can issue debt at a rate ofre -10%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $4 per year at $42 per share. Also, its common stock currently sells for $37 per...
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 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 rd = 9%, and its tax rate is 35%. It can issue preferred stock that pays a constant dividend of $6 per year at $46 per share. Also, its common...
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 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 rd = 10%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $5 per year at $54 per share. Also, its common...
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