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Start with the partial model in the file Ch09 P18 Build a Model.xlsx on the textbooks Web site. The stock of Gao Computing sells for $50, and last years dividend was $2.10. A flotation cost of 10% would be required to issue new common stock. Gaos preferred stock pays a dividend of $3.30 per share, and new preferred stock could be sold at a price to net the company $30 per share. Security analysts are projecting that the common dividend will grow at a rate of 7% a year. The firm can issue additional long-term debt at an interest rate (or a before-tax cost) of 10%, and its marginal tax rate is 25%. The market risk premium is 6%, the risk-free rate is 6.5%, and Gaos beta is 0.83. In its cost-of-capital calculations, Gao uses a target capital structure with 30% debt, 10% preferred stock, and 60% common equity.

e. Suppose Gao is evaluating three projects with the following characteristics: (1) Each project has a cost of $1 million. They will all be financed using the target mix of long-term debt, preferred stock, and common equity. The cost of the common equity for each project should be based on the beta estimated for the project. All equity will come from reinvested earnings. (2) Equity invested in Project A would have a beta of 0.5. The project has an expected return of 9.0%. (3) Equity invested in Project B would have a beta of 1.0. The project has an expected return of 10.0%. (4) Equity invested in Project C would have a beta of 2.0. The project has an expected return of 11.0%. Analyze the company's situation by estimating r, for each beta and the resulting WACCs below. (12 points) Expected return on Beta WACC project Project A 0.5 Project B Project C 2.0 1.0 3. Capital Budgeting Decisions f. For each project, state whether the project should be accepted or should be rejected. Explain why each project should be accepted or rejected. (4 points) e. Suppose Gao is evaluating three projects with the following characteristics: (1) Each project has a cost of $1 million. They will all be financed using the target mix of long-term debt, preferred stock, and common equity. The cost of the common equity for each project should be based on the beta estimated for the project. All equity will come from reinvested earnings. (2) Equity invested in Project A would have a beta of 0.5. The project has an expected return of 9.0%. (3) Equity invested in Project B would have a beta of 1.0. The project has an expected return of 10.0%. (4) Equity invested in Project C would have a beta of 2.0. The project has an expected return of 11.0%. Analyze the company's situation by estimating r, for each beta and the resulting WACCs below. (12 points) Expected return on Beta WACC project Project A 0.5 Project B Project C 2.0 1.0 3. Capital Budgeting Decisions f. For each project, state whether the project should be accepted or should be rejected. Explain why each project should be accepted or rejected. (4 points)