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Why hd ltd cannot use firm wacc to evaluate standalone

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Reference no: EM132804604

HD Ltd has determined its optimal capital structure, which is composed of the following sources and target market value proportions:

Source of Capital
Long-term debt 30% Preferred stock 5% Common stock equity 65%

Target Market Proportions

(i) Debt: The firm can sell a 10-year, $1,000 par value, 6 percent bond for $1,000.

(ii) Preferred Stock: The firm has determined it can issue preferred stock at $65 per share par value. The stock will pay an $8.00 annual dividend.

(iii) Common Stock: The firm's common stock is currently selling for $40 per share. The dividend expected to be paid at the end of the coming year is $5.07. Its dividend payments have been growing at a constant rate for the last five years. Five years ago, the dividend was $3.45. Additionally, the firm's marginal tax rate is 40 percent.

Problem (a) Calculate the costs of debt, preferred stock, and equity of HD Ltd.

Problem (b) Calculate HD Ltd.'s weighted average cost of capital (WACC) assuming the firm has exhausted all retained earnings. Why HD Ltd. cannot use firm's WACC to evaluate its standalone projects, and what are possible remedies to adjust it to suit the standalone projects?

Reference no: EM132804604

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