LEI has the following capital structure, which it considers to be optimal:

Debt 25%

Preferred stock 15

Common equity 60 

100 

LEI’s expected net income this year is $34, 285.72, its established dividend payout ratio is 30%, its tax rate is 40% and investors expect earnings and dividends to grow at a constant rate of 9% in the future. LEI paid a dividend of $3.60 per share last year, and its stock currently sells at a price of $54 per share.

LEI can obtain new capital in the following ways:

· Preferred: New preferred stock with a dividend of $11 can be sold to the public at a price of $95 per share.

· Debt: Debt can be sold at an interest rate of 12%.

a) Determine the cost of each capital structure component. [2+2+2=6]

b) Calculate the Weighted average cost of capital (WACC). [4]

c) LEI has the following investment opportunities that are typical average-risk projects for the firm:

PROJECT COST AT t=0 RATE OF RETURN

A $10,000 17.4%

B 20,000 16.0

C 10,000 14.2

D 20,000 14.2

E 10,000 12.0

Which projects should LEI accept? Why? [2]

d) If the company follows a residual dividend policy, what will be its payout ratio? [6]