Question #2: IBM has the following capital structure, which it considers to be optimal:

Debt = $20,000

Preferred Stock = $30,000

Common Equity = $50,000

$100,000

IBMs expected net income this year is $34,285.72, its established dividend payout ratio is 30%, its federal-plus-state tax rate is 40%, and investors expect earnings and dividends to grow at a constant rate of 9% in the future. Next year, IBM expects to pay dividends of $3.60 per share and its stock currently sells for $54 per share.

IBM can obtain new capital in the following ways:

Preferred: New preferred stock with a dividend of $10 can be sold to the public at a price of $70 per share.

Debt: Debt can be sold at an interest rate of 13 percent.

1. Determine the after-tax cost of each capital component:

Cost of Debt: _________________________

Aftertax Cost of Debt: _________________________

Cost of Preferred: _____________________________________________

Cost of Common Stock: _________________________________________

Write the WACC formula : ________________________________________

1. Calculate WACC

1. IBM has the following investment opportunities that are average-risk projects for the firm:

Project Cost at t=0 Rate of Return

A $40,000 17 %

B 25,000 6.0 %

C 30,000 24.2 %

D 20,000 13.7 %

E 70,000 34.0 %

Considering the WACC, which projects should IBM accept assuming a total budget of $60,000? Fully explain why.