Question
Excel Online Structured Activity: WACC and optimal capital budget Adamson Corporation is considering four average-risk projects with the following costs and rates of return: Project
Excel Online Structured Activity: WACC and optimal capital budget
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 rd = 10%, and its tax rate is 35%. It can issue preferred stock that pays a constant dividend of $5 per year at $48 per share. Also, its common stock currently sells for $37 per share; the next expected dividend, D1, is $4.50; 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. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below.
Open spreadsheet
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What is the cost of each of the capital components? Round your answers to two decimal places. Do not round your intermediate calculations.
Cost of debt %
Cost of preferred stock %
Cost of retained earnings %
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What is Adamson's WACC? Round your answer to two decimal places. Do not round your intermediate calculations.
%
| WACC and optimal capital budget | ||||
| Cost of debt, rd | 10.00% | |||
| Tax rate, T | 35.00% | |||
| Preferred dividend | $5.00 | |||
| Preferred stock price, Pp | $48.00 | |||
| Common stock price, P0 | $37.00 | |||
| Expected common dividend, D1 | $4.50 | |||
| Common stock constant growth rate, gn | 5.00% | |||
| % common stock in capital structure | 75.00% | |||
| % debt in capital structure | 15.00% | |||
| % preferred stock in capital structure | 10.00% | |||
| "Cost of capital components & WACC calculation:" | Weights | After-tax Cost | Weighted Cost | |
| After-tax cost of debt, rd(1 T) | 15.00% | |||
| Cost of preferred stock, rp | 10.00% | |||
| Cost of common stock, rs | 75.00% | |||
| WACC = | ||||
| Project acceptance analysis: | ||||
| Projects | Cost | Expected Rate of Return | Accept Project? Y/N | |
| 1 | $2,000 | 16.00% | ||
| 2 | $3,000 | 15.00% | ||
| 3 | $5,000 | 13.75% | ||
| 4 | $2,000 | 12.50% | ||
| Formulas | ||||
| "Cost of capital components & WACC calculation:" | Weights | After-tax Cost | Weighted Cost | |
| After-tax cost of debt, rd(1 T) | 15.00% | #N/A | #N/A | |
| Cost of preferred stock, rp | 10.00% | #N/A | #N/A | |
| Cost of common stock, rs | 75.00% | #N/A | #N/A | |
| WACC = | #N/A | |||
| Project acceptance analysis: | ||||
| Projects | Cost | Expected Rate of Return | Accept Project? Y/N | |
| 1 | $2,000 | 16.00% | #N/A | |
| 2 | $3,000 | 15.00% | #N/A | |
| 3 | $5,000 | 13.75% | #N/A | |
| 4 | $2,000 | 12.50% | #N/A | |
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Multinational Business Finance
Authors: David K. Eiteman, Arthur I. Stonehill, Michael H. Moffett
16th Edition
013749601X, 978-0137496013
