Adamson Corporation is considering four average-risk projects with the following costs and rates of return:

Project Cost Expected Rate of Return
1 $2,000 16.00%
2 3,000 15.00
3 5,000 13.75
4 2,000 12.50

The company estimates that it can issue debt at a rate of rd = 10%, and its tax rate is 30%. It can issue preferred stock that pays a constant dividend of $5 per year at $48 per share. Also, its common stock currently sells for $33 per share; the next expected dividend, D1, is $4.00; and the dividend is expected to grow at a constant rate of 5% per year. The target capital structure consists of 75% common stock, 15% debt, and 10% preferred stock.

Required:
a. What is the cost of each of the capital components?
b. What is Adamson's WACC?

Answer:

a. Cost of debt = Interest * (1 - Tax rate)

= 10%*(1 - 0.30)

= 7%

Cost of preferred stock = Dividend/ Issue price

= 5/48

= 10.42%

Cost of common stock (Cost of retained earnings) = (D1/P0) + g

= (4/33) + 0.07

= 0.12 + 0.07

= 0.19

= 19%

b. Fund                         Cost        Weight       Cost * Weight

Debt                           7%          0.15                 1.05%

Preferred stock        10.42%     0.10                1.042%

Retained earnings     19%         0.75               14.25%

WACC                                                               16.342%

Saul is a manager at Holden Apparels Inc. and is friends with the company's CEO. This privilege gives Saul the information that Holden Apparels is in the midst of talks to take over a leading rival. Saul buys stocks of Holden with the expectation that its stocks will appreciate. But the deal falls through and the stocks of Holden depreciate in the following months. Are Saul's actions unethical