Check My Work (1 remaining) Problem 10-18 WACC and optimal capital budget Adamso
ID: 2795400 • Letter: C
Question
Check My Work (1 remaining)
Problem 10-18
WACC and optimal capital budget
Adamson Corporation is considering four average-risk projects with the following costs and rates of return:
The company estimates that it can issue debt at a rate of rd = 11%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $3 per year at $42 per share. Also, its common stock currently sells for $38 per share; the next expected dividend, D1, is $3.75; and the dividend is expected to grow at a constant rate of 6% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock.
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 ______ %
What is Adamson's WACC? Round your answer to two decimal places. Do not round your intermediate calculations.
_______%
Problem 10-18
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 1 $2,000 16.00% 2 3,000 15.00 3 5,000 13.75 4 2,000 12.50The company estimates that it can issue debt at a rate of rd = 11%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $3 per year at $42 per share. Also, its common stock currently sells for $38 per share; the next expected dividend, D1, is $3.75; and the dividend is expected to grow at a constant rate of 6% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock.
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 ______ %
What is Adamson's WACC? Round your answer to two decimal places. Do not round your intermediate calculations.
_______%
Explanation / Answer
1 cost of each of the capital components? Cost of the debt = debt rate (1- tax rate) =11% *(1-0.30) =7.70% Cost preference stock = Dividend / preference stock =$3/$42 *100 =7.14% Cost of Common stock = 3.75/38 *100 +6% =15.87% 2 Adamson's WACC? WACC = (Weight of Debt * Cost of debt) + ( Weight of preference stock * Cost of Preference stock) + ( Weight of Common Stock * Cost of Common stock) WACC = (0.15*7.70%) + (0.10*7.14%) +(0.75*15.87%) WACC =1.155%+0.714%+11.9025% =13.77% 3 Only projects with expected returns that exceed WACC will be accepted. Which projects should Adamson accept Only project 1 and Project 2 can be accepted. Because it expected return exceeds WACC of Adamson