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 = 9%, and its tax rate is 35%. It can issue preferred stock that pays a constant dividend of $4 per year at $41 per share. Also, its common stock currently sells for $30 per share; the next expected dividend, D₁, is $3.00; 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. 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 = ______ %
Cost of retained earnings = _______ %

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

Answer 1

(a) rd= 9 % and Tax Rate = 35 %

After-Tax Cost of Debt = kd = 9 x (1-0.35) = 5.85 %

Constant Preferred Stock Dividend = Dp = $ 4 and Price of Preferred Stock = $ 41

Cost of Preferred Stock = kp = Dp / Price = 4 /41 = 0.097561 or 9.7561 %

Expected Dividend = D1 = $ 3, Current Common Stock Proce = P0 = $ 30, Perpetual Growth Rate = g = 6 %

Cost of Common Stock = ke = (D1/P0) + g = (3/30) + 0.06 = 0.16 or 16 %

(b) Debt Proportion = D = 15 % or 0.15, Common Stock Proportion = E = 75 % or 0.75 and Preferred Stock Proportion = P = 10 % or 0.1

WACC = kd X D + ke X E + kp X P = 5.85 x 0.15 + 16 x 0.75 + 9.7561 x 0.1 = 13.853 % ~ 13.85 %