Adamson Corporation is considering four averagerisk projects with the following costs and rates of return:
The company estimates that it can issue debt at a rate of r_{d} = 11%, and its tax rate is 25%. It can issue preferred stock that pays a constant dividend of $7.00 per year at $57.00 per share. Also, its common stock currently sells for $51.00 per share; the next expected dividend, D_{1}, is $4.75; and the dividend is expected to grow at a constant rate of 6% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock.

a. cost of debt is computed as follows:
= rd x (1  tax rate)
= 11% x (1  0.25)
= 8.25%
cost of preferred stock is computed as follows:
= Dividend / Price
= $ 7 / $ 57
= 12.28070175% or 12.28% Approximately
Cost of retained earnings is computed as follows:
= (D1 / P0) + growth rate
= ($ 4.75 / $ 51) + 6%
= 15.31372549% or 15.31% Approximately
b. WACC is as follows:
= cost of debt x weight of debt + cost of preferred stock x weight of preferred stock + cost of retained earnings x weight of retained earnings
= 8.25% x 15% + 12.28070175% x 10% + 15.31372549% x 75%
= 13.95%
c. So, the projects that shall be accepted will be as follows:
Project 1 and Project 2 (Since rate of return exceeds WACC)
Projects that shall be rejected will be as follows:
Project 3 and Project 4 (Since rate of return is less than WACC)
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