Question
WACC and optimal capital budget Adams Corporation is considering four average-risk projects with the following costs and rates of return: Project Cost Expected Rate of
WACC and optimal capital budget Adams Corporation is considering four average-risk projects with the following costs and rates of return:
Project | Cost | Expected Rate of Return |
1 | $2,000 | 16.00% |
2 | 3,000 | 15.00 |
3 | 5,000 | 13.75 |
4 | 2,000 | 12.50 |
The company estimates that it can issue debt at a rate of rd = 10%, and its tax rate is 40%. It can issue preferred stock that pays a constant dividend of $6 per year at $53 per share. Also, its common stock currently sells for $35 per share; the next expected dividend, D1, is $3.25; 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.
a. What is the cost of each of the capital components? Round your answers to two decimal places. Cost of debt % Cost of preferred stock % Cost of retained earnings %
b. What is Adams' WACC? Round your answer to two decimal places. %
c. Only projects with expected returns that exceed WACC will be accepted. Which projects should Adams accept?
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