Midwest Water Works estimates that its WACC is 10.5%. The company is considering the following capital budgeting projects: $$ \begin{matrix} \text{Project } & \text{Size} & \text{Rate of Return}\\ \text{A} & \text{\$ 1 million} & \text{12.0\\%}\\ \text{B} & \text{2 million} & \text{11.5}\\ \text{C} & \text{2 million} & \text{11.2}\\ \text{D} & \text{2 million} & \text{11.0}\\ \text{E} & \text{1 million} & \text{10.7}\\ \text{F} & \text{1 million} & \text{10.3}\\ \text{G} & \text{1 million} & \text{10.2}\\ \end{matrix} $$ Assume that each of these projects is just as risky as the firm’s existing assets and that the firm may accept all the projects or only some of them. Which set of projects should be accepted? Explain.

Midwest Water Works estimates that its WACC is 10.5 percent. The company is considering the following capital budgeting projects:

$$\begin{array}{ccc} \text { Project } & \text { Size } & \text { Rate of Return } \\ \hline \text { A } & 1 \text { million dollars } & 12.0 \text{ percent} \\ \text { B } & 2 \text { million } & 11.5 \\ \text { C } & 2 \text { million } & 11.2 \\ \text { D } & 2 \text { million } & 11.0 \\ \text { E } & 1 \text { million } & 10.7 \\ \text { F } & 1 \text { million } & 10.3 \\ \text { G } & 1 \text { million } & 10.2 \end{array}$$

Assume that each of these projects is just as risky as the firm’s existing assets and that the firm may accept all the projects or only some of them. Which set of projects should be accepted? Explain.

Torch Industries can issue perpetual preferred stock at a price of $57.00 a share. The stock would pay a constant annual dividend of$6.00 a share. What is the company’s cost of preferred stock, $\mathrm{T}_{\mathrm{P}} ?$

The Holmes Company’s currently outstanding bonds have an 8% coupon and a 10% yield to maturity. Holmes believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 40%, what is Holmes’ after-tax cost of debt?

Percy Motors has a target capital structure of $40 \%$ debt and $60 \%$ common equity, with no preferred stock. The yield to maturity on the company's outstanding bonds is $9 \%$, and its tax rate is $40 \%$. Percy's CFO estimates that the company's WACC is $9.96 \%$. What is Percy's cost of common equity?

The future earnings, dividends, and common stock price of Callahan Technologies Inc. are expected to grow 6 percent per year. Callahan's common stock currently sells for 22.00 dollars per share, its last dividend was 2.00 dollars, and it will pay a 2.12 dollars dividend at the end of the current year.

a. Using the DCF approach, what is its cost of common equity?

b. If the firm's beta is 1.2, the risk-free rate is 6 percent, and the average return on the market is 13 percent, what will be the firm's cost of common equity using the CAPM approach?

c. If the firm's bonds earn a return of 11 percent, based on the bond-yield-plus-risk-premium approach, what will be $r_s$ ? Use the midpoint of the risk premium range discussed in the lessons before in your calculations.

d. If you have equal confidence in the inputs used for the three approaches, what is your estimate of Callahan's cost of common equity?

Suppose a firm estimates its WACC to be 10%. Should the WACC be used to evaluate all of its potential projects, even if they vary in risk? If not, what might be “reasonable” costs of capital for average-, high-, and low-risk projects?

Banyan Co.’s common stock currently sells for $46.75 per share. The growth rate is a constant 6%, and the company has an expected dividend yield of 5%. The expected long-run dividend payout ratio is 20%, and the expected return on equity (ROE) is 7.5%. New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred. What would be the cost of new equity?

The Paulson Company’s year-end balance sheet is shown below. Its cost of common equity is 14%, its before-tax cost of debt is 10%, and its marginal tax rate is 40%. Assume that the firm’s long-term debt sells at par value. The firm’s total debt, which is the sum of the company’s short-term debt and long-term debt, equals $1,167. The firm has 576 shares of common stock outstanding that sell for$4.00 per share. Calculate Paulson’s WACC using market-value weights.

$$\begin{matrix} \text{Assets} & \text{ } & \text{Liabilities and Equity}\\ \text{Cash} & \text{\$ 120} & \text{Accounts payable and accruals} & \text{\$ 10}\\ \text{Accounts receivable} & \text{240} & \text{Short-term debt} & \text{47}\\ \text{Inventories} & \text{360} & \text{Long-term debt} & \text{1.120}\\ \text{Plant and equipment, net} & \text{2.160} & \text{Common equity} & \text{1.703}\\ \text{Total assets} & \text{\$ 2.880} & \text{Total liabilities and equity} & \text{\$ 2.880}\\ \end{matrix}$$

Palencia Paints Corporation has a target capital structure of 35% debt and 65% common equity, with no preferred stock. Its before-tax cost of debt is 8%, and its marginal tax rate is 40%. The current stock price is $\mathrm{P}_{0}=\$ 22.00$. The last dividend was $\mathrm{D}_{0}=\$ 2.25$, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC?

Hook Industries’s capital structure consists solely of debt and common equity. It can issue debt at $r_{d}=11 \%$, and its common stock currently pays a $2.00 dividend per share$\left($\mathrm{D}$_{0}=$2.00\right)$. The stock's price is currently $24.75, its dividend is expected to grow at a constant rate of 7% per year, its tax rate is 35%, and its WACC is 13.95%. What percentage of the company’s capital structure consists of debt?

The Evanec Company's next expected dividend, $D_1$, is $\$ 3.18$; its growth rate is $6 \%$; and its common stock now sells for $\$ 36.00$. New stock (external equity) can be sold to net $\$ 32.40$ per share.

What is Evanec's cost of new common stock, $r_e$ ?

The Evanec Company's next expected dividend, $D_1$, is $\$ 3.18$; its growth rate is $6 \%$; and its common stock now sells for $\$ 36.00$. New stock (external equity) can be sold to net $\$ 32.40$ per share.

What is Evanec's percentage flotation cost, F?

Klose Outfitters Inc. believes that its optimal capital structure consists of $60 \%$ common equity and $40 \%$ debt, and its tax rate is $40 \%$. Klose must raise additional capital to fund its upcoming expansion. The firm will have $\$ 2$ million of retained earnings with a cost of $r_5=12 \%$. New common stock in an amount up to $\$ 6$ million would have a cost of $\mathrm{r}_{\mathrm{e}}=15 \%$. Furthermore, Klose can raise up to $\$ 3$ million of debt at an interest rate of $\mathbf{r}_{\mathrm{d}}=10 \%$ and an additional $\$ 4$ million of debt at $\mathrm{r}_{\mathrm{d}}=12 \%$. The CFO estimates that a proposed expansion would require an investment of $\$ 5.9$ million. What is the WACC for the last dollar raised to complete the expansion?