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Question - McAleer Securities is considering an investment project it expects to earn 7.4% on. McAleer's desired funding mix is 50% debt, 10% preferred stock and 40% common stock. Currently McAleer's cost of debt is 6.5%, and its cost of preferred stock is 8%. McAleer plans to pay a $1.80 dividend on its common stock next year, which is growing at 4%. McAleer's corporate tax rate is 24%, and its stock sells for $25 right now.
McAleer's after-tax cost of debt: 4.94%
McAleer's cost of preferred stock: 8.00%
McAleer's expected return on common stock: 11.20%
McAleer's WACC: 7.75%
Required -
1. Which type of funding costs the most return, and the least? (Consider WAC formula)
2. How can a company reduce its WACC? (Consider the mix of the funding in the formula)
3. Can it be considered as a good business strategy? If so what risks are involved?
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