Project $2,000 16.00% 15.00 13.75 ,000 The cor..ny currenty selS for D9 per shar

Question

Project $2,000 16.00% 15.00 13.75 ,000 The cor..ny currenty selS for D9 per share, the next expected dwidend, Di, tsg4.75, estimates that t can issue dent et a rate ote-"w.and its tax rate is 35%.ncan issue pre erred stok that pays a constant dividend of the vidend $3 per year t $45 per share, Also, s common stock isexpected grow at a constant rate of 5% per year. The target capita, structweconsists of 75% common a. What is the cost of each of the capital components? Round your anawers to two decimal places. Do not round your intermediate cakoulations Cost of debt Cost of retained earnings Project 1 Project 2 Project 3 Project 4

Explanation / Answer

a) Cost of debt = rate*(1-tax rate)= 11(1-0.35)=7.15%
Cost of preferred stock = Dividend/Share price = 3/45=6.67%
Cost of common stock = cost of retained earnings
According to Dividend discount model:
Price= Dividend/(Required return-growth rate)
39=4.75/(Required return- 0.05)
Required return = 17.18%
Cost of retained earnings = 17.18%
Cost of retained earning=17.18%

b)

WACC=14.62%

c) Project 1= Accepted as rate is higher than 14.62
Project 2=  Accepted as rate is higher than 14.62
Project 3= Rejected as rate is less than 14.62
Project 4= Rejected as rate is less than 14.62

Weight Cost Weighted cost Common stock 0.75 17.1795 12.884625 Debt 0.15 7.15 1.0725 Preferred stock 0.1 6.66667 0.666667 SUM 14.62

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