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 35%. It can issue preferred stock that pays a constant dividend of $3 per year at $44 per share. Also, its common stock currently sells for $36 per share; the next expected dividend, D₁, is $3.50; 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

1. 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 %

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

   %

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

   Project 1	_______acceptreject
   Project 2	_______acceptreject
   Project 3	_______acceptreject
   Project 4	_______acceptreject

B19 в со 1 WACC Cost of common equity (r) Before-tax cost of debt (r.) Marginal tax rate (0) Common shares outstanding Current stock price Long-term debt sells at par value 16.00% 8.00% 40.00% 576 $4.00 Yes 6 7 8 $10.00 10 Balance Sheet: 11 Assets 12 Cash 13 Account receivable 14 Inventories 15 Plant and equipment, net 16 Total assets $120.00 $240.00 $360.00 $2.160.00 $2.880.00 Liabilities and Equity Accounts payable and accruals Short-term debt Long-term debt Common equity Total liabilities and equity $48.00 $1,100.00 $1,722.00 $2.880.00

Answer 1

1.
=11%*(1-35%)
=7.15%

2.
=3/44
=6.82%

3.
=3.50/36+7%
=16.72%

4.
=75%*(3.50/36+7%)+15%*(11%*(1-35%))+10%*(3/44)
=14.30%

5.
Project 1 Accept
Project 2 Accept
Project 3 Reject
Project 4 Reject