Stock W has the following returns for various states of the economy:

State of the Economy Probability Stock W's Return

Recession 25% -22%

Average 55% 16%

Boom 20% 35%

Stock W's expected rate of return is

14.63%

13.51%

10.30%

12.68%

You are working as a finance manager to the TWU Athletic Clothing Company, and you have been asked to compute the appropriate discount rate to use in the evaluation of the purchase of a new warehouse facility. You have determined the target mix of financing sources of the firm's current capital structure as follows: $300,000 bonds, $200,000 preferred stock, and $500,000 common stock.

To finance the purchase, TWU Athletic will sell 20-year bonds with a $1,000 par value paying 6.0 percent per year (with interest paid semiannually) at the market price of $1,020.

Preferred stock paying a $2.50 dividend can be sold for $35.00.

Common stock for TWU Athletic is currently selling for $50.00 per share. The firm paid a $4.00 dividend last year and expects dividends to continue growing at a rate of 4.0 percent per year for the indefinite future. (Assume no flotation cost.)

The firm's tax rate is 34 percent.

What discount rate (WACC) should you use to evaluate the warehouse project?

A - 9.98%

B - 8.74%

C - 6.54%

D - 7.41%