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 Expected Rate of Return 16.00% $2,000 3,000 15.00 WN 5,000 13.75 2,000 12.50 The company estimates that it can issue debt at a rate of ra 11%, and its tax rate is 30%. 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 $40 per share; the next expected dividend, D, is $3.75; 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.

Answer 1

a) cost of debt=rd(1- tax rate)

=11%*(1-.3)=7.7%

cost of preferred stock=(preferred dividend/ preferred stock price)*100=6/59*100=10.17%

cost of equity= (dividend per share/ market price per share)+expected growth in dividends

=(3.75/40)+7%=9.38+7=16.38%

b) weighed average cost of capital(WACC)=cost of equity*weightage of equity+cost of prefered stock*weightage of prefered stock+cost of debt*weightage of debt

=75%*16.38+10%*10.17+15%*7.7

=12.285+1.017+1.155

=14.457%

c)Projects 1 and 2 should be accepted whose expected return is higher than WACC while projects 3 and 4 should be rejected as they yield lower than WACC