Midwest Electric Company (MEC) uses only debt and common equity. It can borrow u

Question

Midwest Electric Company (MEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of rd = 9% as long as it finances at its target capital structure, which calls for 40% debt and 60% common equity. Its last dividend (D0) was $2.00, its expected constant growth rate is 6%, and its common stock sells for $22. MEC's tax rate is 40%. Two projects are available: Project A has a rate of return of 13%, while Project B's return is 9%. These two projects are equally risky and about as risky as the firm's existing assets.

What is its cost of common equity? Round your answer to two decimal places.
%

What is the WACC? Round your answer to two decimal places.
%

Which projects should Midwest accept?
-Select-Project AProject B

Explanation / Answer

Step-1:

Cost of equity:

= Devidend per share / current market value of stock + Growth rate

= $2 / $22 +6%

= 6.090%

Step-2:

Calculation of WACC

= rd (1-tc) * D / V) + re * (E/V)

= 40% ( 1- 0.40) * (40% / 100) + 60% * (60% / 10%)

= 9.6 + 36

WACC = 45.6

Step-3:

It’s better to accept the project A, because the risky will same for the both projects and return will be more than the project B.

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