Question
A company has outstanding debt with a market value of $400 million, preferred stock with a market value of $150 million and common stock with
A company has outstanding debt with a market value of $400 million, preferred stock with a market value of $150 million and common stock with a market value of $600 million. Debt, preferred stock and equity are listed on the balance sheet for $400 million, $80 million and $250 million, respectively. If its debt has a before-tax cost of 6%, preferred stock a cost of 4%, equity a cost of 8% and a corporate tax rate of 40%, what is the WACC that this firm should use to evaluate average-risk projects? If management adds 2 percentage points to the cost of equity for projects with above-average risk, should it accept a project with an expected rate of return of 9%? Why or why not?
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