WACC AND OPTIMAL CAPITAL BUDGET Adams Corporation is considering four averagerisk 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 10%, and its tax rate is 30%.

It can issue preferred stock that pays a constant dividend of $5 00 per year at $49 00 per share. Also, its common stock currently sells for $36 00 per share; the next expected dividend, D1 is $3 50; 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?

b. What is Adams’ WACC?

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

AppendixLO1