Question

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

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 rd = 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 = _______ %

= _______%

(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 %

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