| 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 = 11%, and its tax rate is 35%. It can issue preferred stock that pays a constant dividend of $4 per year at $56 per share. Also, its common stock currently sells for $31 per share; the next expected dividend, D1, is $3.25; 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.
| Cost of debt, rd | 11.00% | ||
| Tax rate, T | 35.00% | ||
| Preferred dividend | $4.00 | ||
| Preferred stock price, Pp | $56.00 | ||
| Common stock price, P0 | $31.00 | ||
| Expected common dividend, D1 | $3.25 | ||
| Common stock constant growth rate, gn | 7.00% | ||
| % common stock in capital structure | 75.00% | ||
| % debt in capital structure | 15.00% | ||
| % preferred stock in capital structure | 10.00% | ||
|
Cost of capital components & WACC calculation: |
Weights | After-tax Cost | Weighted Cost |
| After-tax cost of debt, rd(1 – T) | 15.00% | ||
| Cost of preferred stock, rp | 10.00% | ||
| Cost of common stock, rs | 75.00% | ||
| Project acceptance analysis: | |||
| Projects | Cost | Expected Rate of Return | Accept Project? Y/N |
| 1 | $2,000 | 16.00% | |
| 2 | $3,000 | 15.00% | |
| 3 | $5,000 | 13.75% | |
| 4 | $2,000 | 12.50% | |
|
Cost of capital components & WACC calculation: |
Weights | After-tax Cost | Weighted Cost |
| After-tax cost of debt, rd(1 – T) | 15.00% | #N/A | #N/A |
| Cost of preferred stock, rp | 10.00% | #N/A | #N/A |
| Cost of common stock, rs | 75.00% | #N/A | #N/A |
| WACC = | #N/A | ||
| Projects | Cost | Expected Rate of Return | Accept Project? Y/N |
| 1 | $2,000 | 16.00% | #N/A |
| 2 | $3,000 | 15.00% | #N/A |
| 3 | $5,000 | 13.75% | #N/A |
| 4 | $2,000 | 12.50% | #N/A |
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 %
1. after tax cost of debt=cost of debt*(1-tax rate)=11%*(1-35%)=7.15%
Weighted cost of debt=Weight of debt*after tax cost of debt=15%*7.15%=1.0725%
Cost of preferred stock=annual dividend/price of preferred stock=4/56=7.14%
weighted cost of preferred stock=weight of preferred stock*cost of preferred stock=10%*7.14%=0.714%
Cost of common stcok=(Dividend next year/common share price)+growth rate=(3.25/31)+7%=17.48%
Weight cost of common stock=weight of common stock*cost of common stock=75%*17.48%=13.11%
WACC=Weighted cost of debt+weighted cost of preferred stock+Weight cost of common stock=1.0725%+0.714%+13.11%=14.90%
2.
| Cost | Expected rate of return | Accept Project? | Remarks | |
| Project1 | 2000 | 16% | Yes | Expected rate>WACC |
| Project2 | 3000 | 15% | Yes | Expected rate>WACC |
| Project3 | 5000 | 13.75% | No | Expected rate<WACC |
| Project4 | 2000 | 12.50% | No | Expected rate<WACC |
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