The financial vice president, Katherine Barnes, has provided you with the following data, which she believes may be relevant to your task. The firms tax rate is 40%. The current price of Deeres 12% coupon, semiannual payment, noncallable bonds with 15 years remaining to maturity, is $1,153.72. Deere does not use short-term, interest-bearing debt on a permanent basis. New bonds would be privately placed with no flotation cost. The current price of the firms 10%, $100.00 par value, preferred stock is $111.10. Deeres common stock is currently selling for $50.00 per share. Its last dividend was $4.19, and dividends are expected to grow at a constant annual rate of 5% in the foreseeable future. Deeres beta is 1.2, the yield on T-bonds is 7%, and the market risk premium is estimated to be 6%. For the bond-yield-plus-risk-premium approach, the firm uses a risk premium of 4%. Deeres target capital structure is 30% debt, 10% preferred stock, and 60% common equity

1. What is Deeres overall, or weighted average, cost of capital (WACC) assuming they can fund the project without having to issue new stock?

2. The three projects are similar in size, but different in terms of risk.

Project 1 carries risk that is about average with the firms current level of risk and its expected return is 13.2%.

Project 2 carries less risk than the firms current level of risk and its expected return is 11%

Project 3 carries more risk than the firms current level of risk and has an expected return of 14.3%.

Management has agreed that the hurdle rate should be adjusted by +2% for higher risk projects and -2% for lower risk projects. Based on this rationale, which project should they choose and why?