WACC Empire Electric Company (EEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of r, = 9% as long as it finances at its target capital structure, which calls for 35% debt and 65% common equity. Its last dividend (D) was $2.20, its expected constant growth rate is 6%, and its common stock sells for $26. EEC's tax rate is 40%. Two projects are available: Project A has a rate of return of 12% and Project B's return is 11%. These two projects are equally risky and about as risky as the firm's existing assets. a. What is its cost of common equity? b. What is the WACC? c. Which projects should Empire accept?
WACC Empire Electric Company (EEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of r, = 9% as long as it finances at its target capital structure, which calls for 35% debt and 65% common equity. Its last dividend (D) was $2.20, its expected constant growth rate is 6%, and its common stock sells for $26. EEC's tax rate is 40%. Two projects are available: Project A has a rate of return of 12% and Project B's return is 11%. These two projects are equally risky and about as risky as the firm's existing assets. a. What is its cost of common equity? b. What is the WACC? c. Which projects should Empire accept?
Chapter7: Types And Costs Of Financial Capital
Section: Chapter Questions
Problem 11EP
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Transcribed Image Text:**Weighted Average Cost of Capital (WACC) Analysis**
*Empire Electric Company (EEC) Financial Overview:*
EEC employs a capital structure comprising only of debt and common equity. It can access unlimited borrowing at an interest rate of 9%, provided it adheres to its target capital structure: 35% debt and 65% common equity.
- **Last Dividend (D0):** $2.20
- **Expected Growth Rate:** 6%
- **Current Stock Price:** $26
- **Corporate Tax Rate:** 40%
*Project Opportunities:*
- **Project A:** Expected Rate of Return = 12%
- **Project B:** Expected Rate of Return = 11%
Both projects are considered equally risky and align with the risk profile of the firm’s existing assets.
**Key Questions:**
a. What is EEC’s cost of common equity?
b. What is the Weighted Average Cost of Capital (WACC)?
c. Which projects should Empire Electric accept?
This financial assessment aims to determine the cost parameters that will influence the capital budgeting decisions at EEC.
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