9.
Empire Electric Company (EEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of rd = 10% as long as it finances at its target capital structure, which calls for 30% debt and 70% common equity. Its last dividend (D0) was $2.25, its expected constant growth rate is 4%, and its common stock sells for $29. EEC's tax rate is 25%. Two projects are available: Project A has a rate of return of 12%, and Project B's return is 10%. These two projects are equally risky and about as risky as the firm's existing assets.
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a)
Year 1 dividend = 2.25 (1 + 4%) = 2.34
Cost of common equity = (D1 / price) + growth rate
Cost of common equity = (2.34 / 29) + 0.04
Cost of common equity = 0.08069 + 0.04
Cost of common equity = 0.1207 or 12.07%
b)
WACC = Weights * costs
WACC = 0.3*0.1*(1 - 0.25) + 0.7*0.1207
WACC = 0.0225 + 0.08449
WACC = 0.1070 or 10.70%
c)
Project A should be accepted as it has a higher return
9. Empire Electric Company (EEC) uses only debt and common equity. It can borrow unlimited amounts...
WACC 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 40% debt and 60% common equity. Its last dividend (D0) was $2.25, its expected constant growth rate is 4%, 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...
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