Florida Electric Company (FEC) uses only debt and equity. It can borrow unlimited amounts at an interest rate of 10 percent as long as it finances at its target capital structure, which calls for 45 percent debt and 55 percent common equity. Its last dividend was $2, its expected constant growth rate is 4 percent, its stock sells at a price of $25, and new stock would net the company $20 per share after flotation costs. FEC's marginal tax rate is 40 percent, and it expects to have $100 million of retained earnings this year. Two projects are available: Project A has a cost of $200 million and an expected return of 13 percent, and Project B has a cost of $125 million and an expected return of 10 percent. All of the company's potential projects are equally risky. a. What is FEC's cost of equity from newly issued stock? b. What is FEC's marginal cost of capital-that is, what WACC cost rate should it use to evaluate investment projects (these two projects plus any others that might arise during the year, provided the cost of capital sched- ule remains as it is currently)?
Florida Electric Company (FEC) uses only debt and equity. It can borrow unlimited amounts at an interest rate of 10 percent as long as it finances at its target capital structure, which calls for 45 percent debt and 55 percent common equity. Its last dividend was $2, its expected constant growth rate is 4 percent, its stock sells at a price of $25, and new stock would net the company $20 per share after flotation costs. FEC's marginal tax rate is 40 percent, and it expects to have $100 million of retained earnings this year. Two projects are available: Project A has a cost of $200 million and an expected return of 13 percent, and Project B has a cost of $125 million and an expected return of 10 percent. All of the company's potential projects are equally risky. a. What is FEC's cost of equity from newly issued stock? b. What is FEC's marginal cost of capital-that is, what WACC cost rate should it use to evaluate investment projects (these two projects plus any others that might arise during the year, provided the cost of capital sched- ule remains as it is currently)?
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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Transcribed Image Text:**Weighted Average Cost of Capital (WACC)**
Florida Electric Company (FEC) uses only debt and equity. It can borrow unlimited amounts at an interest rate of 10 percent as long as it finances at its target capital structure, which calls for 45 percent debt and 55 percent common equity. Its last dividend was $2, its expected constant growth rate is 4 percent, its stock sells at a price of $25, and new stock would net the company $20 per share after flotation costs. FEC’s marginal tax rate is 40 percent, and it expects to have $100 million of retained earnings this year.
Two projects are available: Project A has a cost of $200 million and an expected return of 13 percent, and Project B has a cost of $125 million and an expected return of 10 percent. All of the company’s potential projects are equally risky.
a. What is FEC’s cost of equity from newly issued stock?
b. What is FEC’s marginal cost of capital—that is, what WACC cost rate should it use to evaluate investment projects (these two projects plus any others that might arise during the year, provided the cost of capital schedule remains as it is currently)?
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