Empire Electric Company (EEC) uses only debt and common equity. It can borrow un
ID: 2656647 • Letter: E
Question
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 45% debt and 55% common equity. Its last dividend (D0) was $2.75, its expected constant growth rate is 4%, and its common stock sells for $28. 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? Round your answer to two decimal places. Do not round your intermediate calculations.
b- What is the WACC? Round your answer to two decimal places. Do not round your intermediate calculations.
Explanation / Answer
a). Ke = [D0(1 + g) / P0] + g
= [$2.75(1.04) / $28] + 0.04
= 0.1021 + 0.04 = 0.1421, or 14.21%
WACC = [Wd x After-Tax Kd] + [We x Ke]
= [0.45 x 10%(1 - 0.40)] + [0.55 x 14.21%]
= 2.7% + 7.82% = 10.52%
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.