WACC and optimal capital budget Adams Corporation is considering four average-ri
ID: 2672509 • Letter: W
Question
WACC and optimal capital budgetAdams 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 35%. It can issue preferred stock that pays a constant dividend of $4 per year at $59 per share. Also, its common stock currently sells for $31 per share; the next expected dividend, D1, is $3.25; 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.
1. What is the cost of each of the capital components? Round your answers to two decimal places.
Cost of debt ___________________%
Cost of preferred stock 6.78%
Cost of retained earnings ________%
2. What is Adams' WACC? Round your answer to two decimal places.
______%
Explanation / Answer
1. What is the cost of each of the capital components? Round your answers to two decimal places. Cost of debt 10(1-0.35) = 6.5% Cost of preferred stock 6.78% Cost of retained earnings ________% Price = Dividend/ Ke-growth rate of dividend 31 = 3.25/ke-0.06 Ke = 16.49% 2. What is Adams' WACC? Round your answer to two decimal places. 6.5*0.15 + 6.78* 0.1+ 16.49*0.75 = 14.02% answer ______%
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