Project Cost 1 2 $2,000 3,000 5,000 2,000 Expected Rate of Return 16.00% 15.00 13.75 12.50 3 4 The company estimates that it can issue debt at a rate of r, = 10%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $5.00 per year at $50.00 per share. Also, its common stock currently sells for $38.00 per share; the next expected dividend, D, is $4.25, and the dividend is expected to grow at a constant rate of 5% 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? b. What is Adamson's WACC? c. Only projects with expected returns that exceed WACC will be accepted. Which projects should Adamson accept? 10-16 COST OF COMMON EQUITY The Bouchard Company's EPS was $6.50 in 2018, up from $4.42 in 2013. The company pays out 40% of its earnings as dividends, and its common stock sells for $36.00. a. Calculate the past growth rate in earnings. (Hint: This is a 5-year growth period.) b. The last dividend was D= 0.4($6.50) = $2.60. Calculate the next expected dividend, D, assuming that the past growth rate continues. c. What is Bouchard's cost of retained earnings, r? 10-12 WACC Empire Electric Company (EEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of r, = 9% as long as it finances at its target capital structure, which calls for 35% debt and 65% common equity. Its last dividend (D) was $2.20, its expected constant growth rate is 6%, and its common stock sells for $26. EEC's tax rate is 40%. Two projects are available: Project A has a rate of return of 12% and Project B's return is 11%. These two projects are equally risky and about as risky as the firm's existing assets. a. What is its cost of common equity? b. What is the WACC? c. Which projects should Empire accept? 10-12 WACC Empire Electric Company (EEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of ra = 9% as long as it finances at its target capital structure, which calls for 35% debt and 65% common equity. Its last dividend (D) was $2.20, its expected constant growth rate is 6%, and its common stock sells for $26. EEC's tax rate is 40%. Two projects are available: Project A has a rate of return of 12% and Project B's return is 11%. These two projects are equally risky and about as risky as the firm's existing assets. a. What is its cost of common equity? b. What is the WACC? c. Which projects should Empire accept? 10-9 WACC The Paulson Company's year-end balance sheet is shown below. Its cost of com- mon equity is 14%, its before-tax cost of debt is 10%, and its marginal tax rate is 40%. Assume that the firm's long-term debt sells at par value. The firm's total debt, which is the sum of the company's short-term debt and long-term debt, equals $1,167. The firm has 576 shares of common stock outstanding that sell for $4.00 per share. Calculate Paulson's WACC using market value weights. 240 Assets Liabilities and Equity Cash $ 120 Accounts payable and accruals $ 10 Accounts receivable Short-term debt 47 Inventories 360 Long-term debt 1,120 Plant and equipment, net 2,160 Common equity 1,703 Total assets $2,880 Total liabilities and equity $2,880 10-8 COST OF COMMON EQUITY AND WACC Palencia Paints Corporation has a target capital structure of 35% debt and 65% common equity, with no preferred stock. Its before-tax cost of debt is 8%, and its marginal tax rate is 40%. The current stock price is P, = $22.00. The last dividend was D. = $2.25, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC