Question

WACC and optimal capital budget

Adamson Corporation is considering four average-risk projects with the following costs and rates of return: Project Cost Expected Rate 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 = 10%, and its tax rate is 40%. It can issue preferred stock that pays a constant dividend of $3 per year at $55 per share. Also, its common stock currently sells for $36 per share; the next expected dividend, D1, is $3.50; 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.

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 %

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

%

Only projects with expected returns that exceed WACC will be accepted. Which projects should Adamson accept?

Project 1 Project 2 Project 3 Project 4

Answer 1