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.

A) Assuming that Gao will not issue new equity and will continue to use the same target capital structure, what is the companys WACC?

B) 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 and an expected return of 9.0%.

3. Equity invested in Project B would have a beta of 1.0 and an expected return of 10.0%.

4. Equity invested in Project C would have a beta of 2.0 and an expected return of 11.0%.

C) Analyze the companys situation, and explain why each project should be accepted or rejected.

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