Cost of Retained Earnings vs. Cost of Equity company, capital, structure, following, investment

bluejazzy

The following financial data relates to the Carmichael Beverage Company for 2005:
The target capital structure is 65% equity and 35% debt.
After-tax cost of debt is 7%.
Cost of retained earnings is estimated to be 12%.
Cost of equity is estimated to be 13.5% if the company issues new common stock.
Net income is $4,000,000.
Carmichael Beverage Company is considering the following investment projects:
Project A: $2,500,000 value; IRR of 11.50%
Project B: $1,000,000 value; IRR of 13.00%
Project C: $2,000,000 value; IRR of 9.50%
Project D: $500,000 value; IRR of 10.50%
Project E: $1,500,000 value; IRR of 8.00%
If the company follows a residual dividend policy, its payout ratio will be closest to:
A) 0%.
B) 35%.
C) 12%.
Your answer: A was incorrect. The correct answer was B) 35%.
First determine the WACC. WACC = wd