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WACC/Capital Budgeting for Adams Corp.

Adams Corp. is considering four average-risk projects with the following costs & rates of returns:

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%

Adams has a cost of debt = 10%, tax rate is 30%. Adams can issue preferred stock that pays a constant dividend of $5 per year at $49 per share. Adams common stock sells for $36 per share, the next expected dividend, D1, is $3.50, and the dividend is expected to grow at a constant rate of 6% per year. The target capital structure is 75% common stock, 15% debt, and 10% preferred stock.

1) What is the cost of each of the capital components?
2) What is Adams WACC?
3) Which project should Adams accept?

Solution Preview

WACC/Capital Budgeting
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Adams Corp. is considering four average-risk projects with the following costs & rates of returns:

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% ...

Solution Summary

This solution is comprised of a detailed explanation and calculation to compute the cost of each capital component, WACC, and find which project to accept.

$2.19