Question

Empire Electric Company (EEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of rd = 11% as long as it finances at its target capital structure, which calls for 45% debt and 55% common equity. Its last dividend (Do) was $1.95, its expected constant growth rate is 3%, and its common stock sells for $30. EEC's tax rate is 25%. Two projects are available: Project A has a rate of return of 11%, and Project B's return is 8%. 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. c. Which projects should Empire accept? -Select- Project A Project B

Answer 1

After tax cost of Debt = Before tax cost of debt*(1-Tax rate) 0.11*(1-0.25) 0.0825 8.25% a Cost of Equity ((DO*(1+g)/PO)+g ((1.95*(1+0.03)/30) +0.03 0.09695 9.70% weight product Debt Equity cost 0.450 0.550 1.000 8.25% 9.70% 0.037125 0.0533225 0.0904475 b WACC 9.04%! c Accept Project A because its rate of return is more than WACC