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Problem 10-18 in Fundamentals of financial management seventh edition by Brigham and Houston

Adams Corporation is considering four average risk projects with the following costs and rates of return:

project Cost Expected rate of return
1 $2000 16.00%
2 3000 15.00
3 5000 13.75
4 2000 12.50

The company estimates that it can issue debt at a rate of rd=10% and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $5.00 per share at $49.00 per share. Also its common stock currently sells for $36.00 per share, the next expected dividend D1 is $3.50 and the dividend is expected to grow at a constant rate of 6% per yeaer. The target capital structure consists of 75% common stock, 15% debt, and 10% prerferred stock.

a.) What is the cost of each of the capital components?
b.) What is Adam's WACC?
c.) Only projects with expected returns that exceed WACC will be accepted. WHich projects should Adams accept?

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Solution Preview

Please see the Excel file attached for format and formulas.

a) Cost of Debt = rd*(1-tax rate) 7.00%

Cost of ...

Solution Summary

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