18. Problem 10.18 (WACC and Optimal Capital Budget)

eBook Problem Walk-Through

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 = 10%, and its tax rate is 25%. It can issue preferred stock that pays a constant dividend of $4.00 per year at $51.00 per share. Also, its common stock currently sells for $35.00 per share; the next expected dividend, D₁, is $4.25; and the dividend is expected to grow at a constant rate of 4% 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.

   %

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

   Project 1	-Select-AcceptRejectItem 5
   Project 2	-Select-AcceptRejectItem 6
   Project 3	-Select-AcceptRejectItem 7
   Project 4	-Select-AcceptRejectItem 8