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    Risk Adjusted Required Rate of Return, Capital Budgets and Common Stock.

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    1. Your company's overall weighted average required rate of return is 10%. Its yogurt division is riskier than average, it's fresh produce division has average risk, and its institutional foods division has below-average risk. Your company adjusts for both divisional and project risk by adding or subtracting 2 percentage points. Thus, the maximum adjustment is 4 percentage points. What is the risk-adjusted required rate of return for a low-risk project in the yogurt division?

    2. Your company has a capital structure that consists of 20% equity and 80% debt. The company expects to report $3 Million in net income this year, and 60% of the net income will be paid out as dividends. How large can the firm's capital budget be this year without it having to issue any new common stock?

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    Solution Preview

    The WACC is simply the cost of the several types of capital (called capital components) used by a firm, weighted by their proportions in the firm's capital structure. In order to calculate the WACC, the analyst has to estimate
    the cost of debt
    the cost of preferred stock, and
    The cost of common stock

    Risk exists because of the inability of the decision-maker to make perfect forecasts. In formal terms, the risk associated with an investment may be defined as the variability that is likely to occur in the future returns ...

    Solution Summary

    Detailed notes and computation to assist you in learning these concepts.