Question

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

Project	Cost ($)	Expected Return (%)
1	3000	15%
2	2000	16%
3	5000	13.75%
4	2000	12.50%

The company estimates that it can issue debt at a rate of rd = 9%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $6 per year at $50 per share. Also, its common stock currently sells for $40 per share; the next expected dividend, D1, is $4.25; and the dividend is expected to grow at a constant rate of 5% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock.

a. What is the cost of each of the capital components?
b. What is Smith’s WACC?

c. Explain and discuss which projects should Smith accept to invest?

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

C w ENG 08:06 30-07-2020 99+ 27 AE35 < . Y Z AA AB AC AD AE AF 33 ANS A kd = 9%(1-0.3) 6.30% 34 kd = 6.30% 35 36 kp = D/PO kp = 6/50 = 12.0000% 12.00% 37 38 39 40 ke = D1/PO +g ke = 4.25/40 + 0.05 ke = 41 15.6250% 15.63% 42 43 ANS B WACC A B C 44 45 46 SOURCE WEIGHT 75% 15% COMMON STOCK COC (%) 15.63% 6.30% B*C WEIGHTED COST 11.719% 0.945% 47 DEBT PREFERRED STOCK 48 10% 12.00% 1.200% 13.86% WACC = 49 50 51 52 53 ANS C PROJECT EXPECTED RATE OF RETURN WACC REASON SELECTION ACCEPT 1 RETURN > WACC 2 15.00% 16.00% 13.75% 12.50% 13.86% 13.86% 13.86% ACCEPT REJECT 3 54 55 56 RETURN > WACC RETURN < WACC RETURN < WACC 4 13.86% REJECT VAR port future INDEX WACC HEDGE INTL CAP BUD Sheet11 SANDRINE LEASING PORTFOLO Q | DIR right clean YIELD bond ...