Video Excel Online Structured Activity: WACC and optimal capital budget Adamson Corporation is considering four average-risk projects with the following costs and rates of return: Project Cost Expected Rate of Return 16.00% $2,000 3,000 15.00 WN 5,000 13.75 2,000 12.50 The company estimates that it can issue debt at a rate of ra 11%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $6 per year at $59 per share. Also, its common stock currently sells for $40 per share; the next expected dividend, D, is $3.75; and the dividend is expected to grow at a constant rate of 7% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below. Open spreadsheet a. What is the cost of each of the capital components? Round your answers to two decimal places. Do not round, your intermediate calculations. Open spreadsheet a. What is the cost of each of the capital components? Round your answers to two decimal places. Do not round your intermediate calculations. Cost of debt Cost of preferred stock Cost of retained earnings b. What is Adamson's WACC? Round your answer to two decimal places. Do not round your intermediate calculations. c. Only projects with expected returns that exceed WACC will be accepted. Which projects should Adamson accept? Project 1 accept Project 2 accept D Project 3 reject Project 4 reject Checy Work 1 WACC and optimal capital budget 5 6 Cost of debt, a Tax rate, T Preferred dividend Preferred stock price, Pp Common stock price, Po Expected common dividend, D, Common stock constant growth rate, 9 % common stock in capital structure % debt in capital structure % preferred stock in capital structure 11.00% 30.00% $6.00 $59.00 $40.00 $3.75 7.00% 75.00% 15.00% 10.00% 13 14 After-tax Cost Weighted Cost 15 16 17 Cost of capital components & WACC calculation: After-tax cost of debt, Fe(1-T) Cost of preferred stock, Fe. Cost of common stock, r, Weights 15.00% 10.00% 75.00% 18 WACC = 20 Project acceptance analysis: Projects Accept Project? YN Expected Rate of Retum 16.00% 15.00% 13.75% 12.50% Cost $2,000 $3,000 $5,000 $2,000 N Formulas After-tax Cost Cost of capital components & WACC calculation: 30 After-tax cost of debt, ra(1-T) Cost of preferred stock, r. Cost of common stock, rs Weighted Cost #NA Weights 15.00% 10.00% 75.00% #NA WACC - #NA #NA 35 Project acceptance analysis: Projects Accept Project? YN Cost $2,000 $3,000 $5,000 $2,000 Expected Rate of Return 16.00% 15.00% 13.75% 12.50%
