Adams Corporation has four investment opportunities with the following costs and rates of return:
COST RATE OF RETURN
Project 1 $2,000 16.00%
Project 2 $3,000 15.00%
Project 3 $5,000 13.75%
Project 4 $2,000 12.50%
The company estimates that it can issue debt at a before-tax cost of 10 percent, and its tax rate is 30
percent. The company can also issue preferred stock at $49 per share, which pays a constant
dividend of $5 per year. The company’s stock currently sells at $36 per share.
The year-end dividend, D1, is expected to be $3.50, and the dividend is expected
to grow at a constant rate of 6 percent per year.
The company’s capital structure consists of 75 percent common stock, 15 percent debt,
and 10 percent preferred stock.
What is the cost of each of the capital components (debt, preferred equity, and common equity)?
What is the WACC?
Which investments should the firm select if the projects are all of average risk?
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