Question

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

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 r_d = 11%, and its tax rate is 25%. It can issue preferred stock that pays a constant dividend of $6.00 per year at $49.00 per share. Also, its common stock currently sells for $32.00 per share; the next expected dividend, D₁, is $2.75; 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.

1. What is the cost of each of the capital components? Do not round intermediate calculations. Round your answers to two decimal places.

   Cost of debt:   %

   Cost of preferred stock:   %

   Cost of retained earnings:   %

2. What is Adamson's WACC? Do not round intermediate calculations. Round your answer to two decimal places.

     %

Answer 1

Part A:

Cost of debt =rd ( 1 - Tax rate )

= 11% * ( 1 - 0.25 )

= 11% * 0.75

= 8.25%

Cost of Preference share = Pref div / Price

= $ 6 / $ 49

= 0.1224

I,e 12.24%

COst of common stock:

Particulars	Amount
D1	$             2.75
Growth rate	7%
Price	$           32.00

Ke = [ D1 / P0 ] + g
= [ 2.75 / 32 ] + 0.07
= 0.0859 + 0.07
= 0.1559
I.e15.59 %

Where

D1 = Expected Div after 1 Year
P0 = Price Today
Ke = Required Ret
g = Growth Rate

Part B:

WACC is weighted Average cost of sources in capital structure.

Source	Weight	Cost after Tax	Weighted Cost
Debt	0.1500	8.25%	1.24%
Preferred Stock	0.1000	12.24%	1.22%
Equity Stock	0.7500	15.59%	11.69%
WACC			14.15%