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Question - Lancaster Engineering Inc. (LEI) has the following capital structure, which it considers to be optimal:
WACC Preferred stock 15
Common equity 60 100%
Debt 25%
LEI's expected net income this year is $34,285.72, its established dividend payout ratio is 30%, its federal-plus-state tax rate is 40%, and investors expect future earnings and dividends to grow at a constant rate of 9%. LEI paid a dividend of $3.60 per share last year, and its stock currently sells for $54.00 per share. LEI can obtain new capital in the following ways: (1) New preferred stock with a dividend of $11.00 can be sold to the public at a price of $95.00 per share. (2) Debt can be sold at an interest rate of 12%.
a. Determine the cost of each capital component.
b. Calculate the WACC.
c. LEI has the following investment opportunities that are average-risk projects: Which projects should LEI accept? Why? Assume that LEI does not want to issue any new common stock.
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