Question

please answer all parts

Cost Adamson Corporation is consering four average projects with the following costs and rates of return Expected Rate of Return $2.000 16.00 3.000 15.00 5.000 2.000 12.30 The company estimates that it can issue det a t of 10% and tax rate is 2:54. It can we preferred work that pays a constant dividend of $7.00 per year at $49.00 per share. Also, its common stock currently sells for $34.00 per share the next expected hudend, I $3.751 and the dividend is expected to grow a constant rate of 4% per year. The target capital structure consists of 75 common stock, 154 debt and preferred stock What is the cost of each of the capital components? Do not round intermediate calculation Round your answers to two decimal places Cost of debt Cost of preferred to Cost of r ed warnings b. what is Adam WACC) Do not found intermediate cl o s Round you to two decimal aces e. Only with certams that exceed WACC webe which projects that Adamson accept Det Droiect 2 Don 4 Check Work (Remaining)

project 1-4 accept or reject ?

Answer 1

We have D1=4.5, 9=4%, PO=37 interest payments are tax deductible for the firm. Kd after taxes = Kd (1-tax rate) Cost of Debt Kd = (1-T)* Debt rate = (1 - 35%)*11% = 7.15%. Ans(a) Using DCF, (GORDON MODEL) The constant dividend growth model: we have PO=D1/(Ks-g) or Ks = D1/P0 +g where: D1 = next years dividend g= firms constant growth rate PO = price Ks = Cost of retained earnings (ks) is the return stockholders require on the companys common stock. The firms WACC is the cost of Capital for the firms mixture of debt and stock in their capital structure. WACC = wd (cost of debt) + ws (cost of stock/RE) + wp (cost of pf. stock) wd = weight of debt (i.e. fraction of debt in the firm capital structure) WS = weight of stock wp = weight of prefered stock So WACC = Wd*Kd + Ws*ks +Wp*Kp je WACC = 15%*7.15% + 75%*16.16% + 10%*7.15% = 13.91%Ans (d) je Cost of Equity Ks = 4.5/37 +4% = 16.16%............Ans(c) Kp = preferred stock dividend/market price of preferred stock Cost of Pref stock Kp= D/P = 3/52 = 6.77%........ Ans. (b) Since expected return of project A & B exceeds from WACC So both two can be accepted] COST OF DEBT (Kd) We use the after tax cost of debt because