Question

Empire Electric Company (EEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of ra 11 % as long as it finances at its target capital structure,, which calls for 25% debt and 75% common equity. Its last dividend (Do) was $2.40, its expected constant growth rate is 3%, and its common stock sells for $25. EEC's tax rate is 40%. Two projects are available: Project A has a rate of return of 13% , and Project B's return is 9%. These two projects are equally risky and about as risky as the firm's existing assets. a. What is its cost of common equity? Do not round intermediate calculations. Round your answer to two decimal places. % b. What is the WACC? Do not round intermediate calculations. Round your answer to two decimal places. 9% c. Which projects should Empire accept? Select

Answer 1

Answer s. Gordon's Dividend Model (a) Cost of Common Equity, Ke - Dolita) ; g. growth Ale Po Price of stock today Do Dividend just paid ke = 2.4 (1+ 0.03) +0.03 cada 1 25 12.88 % (6) WACC = weighted Average cost of Capital (kd x Wd) + (kexwe) Kd = Cost of Dest (Post tax) Ke= Cost of Equity we Sud - weight of Debt & squity in Capital structore a (6.6*0,25) + (12.88×0.75 11.31% working Kd = - Wd ² we i Interest Rate (1-tar Rote) 11Y (1-0.40) = 6,67 0.25 0.75 (c) - Project A should be expected by Empire, since the Role of Return of Project A is grooter than W ACC (ie. 11.314)