Empire Electric Company (EEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of $r_{d}=9 \%$ structure, which calls for 35% debt and 65% common equity. Its last dividend $\left(D_{0}\right)$ 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?

Palencia Paints Corporation has a target capital structure of 35% debt and 65% common equity, with no preferred stock. Its before-tax cost of debt is 8%, and its marginal tax rate is 40%. The current stock price is $\mathrm{P}_{0}=\$ 22.00$. The last dividend was $\mathrm{D}_{0}=\$ 2.25$, and it is expected to grow at a 5% constant rate. What is its cost of common equity and its WACC?

The Paulson Company’s year-end balance sheet is shown below. Its cost of common equity is 14%, its before-tax cost of debt is 10%, and its marginal tax rate is 40%. Assume that the firm’s long-term debt sells at par value. The firm’s total debt, which is the sum of the company’s short-term debt and long-term debt, equals $1,167. The firm has 576 shares of common stock outstanding that sell for$4.00 per share. Calculate Paulson’s WACC using market-value weights.

$$\begin{matrix} \text{Assets} & \text{ } & \text{Liabilities and Equity}\\ \text{Cash} & \text{\$ 120} & \text{Accounts payable and accruals} & \text{\$ 10}\\ \text{Accounts receivable} & \text{240} & \text{Short-term debt} & \text{47}\\ \text{Inventories} & \text{360} & \text{Long-term debt} & \text{1.120}\\ \text{Plant and equipment, net} & \text{2.160} & \text{Common equity} & \text{1.703}\\ \text{Total assets} & \text{\$ 2.880} & \text{Total liabilities and equity} & \text{\$ 2.880}\\ \end{matrix}$$

The Bouchard Company’s EPS was $6.50 in 2016, up from$4.42 in 2011. The company pays out 40% of its earnings as dividends, and its common stock sells for $36.00. a. Calculate the past growth rate in earnings. (Hint: This is a 5-year growth period.) b. The last dividend was$$\mathrm{D}$_{0}=0.4($6.50)=$ 2.60$. Calculate the next expected dividend, $D_1$, assuming that the past growth rate continues. c. What is Bouchard's cost of retained earnings, $r_s$?

Travis Industries plans to issue perpetual preferred stock with an $11.00 dividend. The stock is currently selling for$108.50, but flotation costs will be 5% of the market price, so the net price will be $103.08 per share. What is the cost of the preferred stock, including flotation?

Banyan Co.’s common stock currently sells for $46.75 per share. The growth rate is a constant 6%, and the company has an expected dividend yield of 5%. The expected long-run dividend payout ratio is 20%, and the expected return on equity (ROE) is 7.5%. New stock can be sold to the public at the current price, but a flotation cost of 5% would be incurred. What would be the cost of new equity?

Midwest Water Works estimates that its WACC is 10.5%. The company is considering the following capital budgeting projects: $$ \begin{matrix} \text{Project } & \text{Size} & \text{Rate of Return}\\ \text{A} & \text{\$ 1 million} & \text{12.0\\%}\\ \text{B} & \text{2 million} & \text{11.5}\\ \text{C} & \text{2 million} & \text{11.2}\\ \text{D} & \text{2 million} & \text{11.0}\\ \text{E} & \text{1 million} & \text{10.7}\\ \text{F} & \text{1 million} & \text{10.3}\\ \text{G} & \text{1 million} & \text{10.2}\\ \end{matrix} $$ Assume that each of these projects is just as risky as the firm’s existing assets and that the firm may accept all the projects or only some of them. Which set of projects should be accepted? Explain.

The Holmes Company’s currently outstanding bonds have an 8% coupon and a 10% yield to maturity. Holmes believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 40%, what is Holmes’ after-tax cost of debt?

The Evanec Company’s next expected dividend, $D_1$, is $3.18; its growth rate is 6%; and its common stock now sells for$36.00. New stock (external equity) can be sold to net $32.40 per share. a. What is Evanec’s cost of retained earnings,$r_s$? b. What is Evanec’s percentage flotation cost, F? c. What is Evanec’s cost of new common stock,$r_e$?

Jarett & Sons’s common stock currently trades at $30.00 a share. It is expected to pay an annual dividend of$1.00 a share at the end of the year $\left(\mathrm{D}_{1}=\$ 1.00\right)$, and the constant growth rate is 4% a year. a. What is the company’s cost of common equity if all of its equity comes from retained earnings? b. If the company issued new stock, it would incur a 10% flotation cost. What would be the cost of equity from new stock?

Torch Industries can issue perpetual preferred stock at a price of $57.00 a share. The stock would pay a constant annual dividend of$6.00 a share. What is the company’s cost of preferred stock, $\mathrm{T}_{\mathrm{P}} ?$

A mining company is deciding whether to open a strip mine, which costs $2 million. Cash inflows of$13 million would occur at the end of Year 1. The land must be returned to its natural state at a cost of $12 million, payable at the end of Year 2. a. Plot the project’s NPV profile. b. Should the project be accepted if WACC=10%? if WACC=20%? Explain your reasoning. c. Think of some other capital budgeting situations in which negative cash flows during or at the end of the project’s life might lead to multiple IRRs. d. What is the project’s MIRR at WACC=10%? At WACC=20%? Does MIRR lead to the same accept/reject decision for this project as the NPV method? Does the MIRR method always lead to the same accept/reject decision as NPV?

Midwest Electric Company (MEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of $r_d=10 \%$ as long as it finances at its target capital structure, which calls for $45 \%$ debt and $55 \%$ common equity. Its last dividend $\left(\mathbf{D}_0\right.$ ) was $\$ 2$, its expected constant growth rate is $4 \%$, and its common stock sells for $\$ 20$. MEC's tax rate is $40 \%$. Two projects are available: Project A has a rate of return of $13 \%$, and Project B's return is $10 \%$. 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 Midwest accept?

On January 1, the total market value of the Tysseland Company was $60 million. During the year, the company plans to raise and invest$30 million in new projects. The firm’s present market value capital structure, shown here, is considered to be optimal. There is no short-term debt.

$$\begin{array}{lr} \text { Debt } & \$ 30,000,000 \\ \text { Common equity } & 30,000,000 \\ \text { Total capital } & \$ 60,000,000 \end{array}$$

New bonds will have an 8% coupon rate, and they will be sold at par. Common stock is currently selling at $30 a share. The stockholders’ required rate of return is estimated to be 12%, consisting of a dividend yield of 4% and an expected constant growth rate of 8%. (The next expected dividend is$1.20, so the dividend yield is $1.20 /$30 = 4%.) The marginal tax rate is 40%.

a. In order to maintain the present capital structure, how much of the new investment must be financed by common equity?

b. Assuming there is sufficient cash flow for Tysseland to maintain its target capital structure without issuing additional shares of equity, what is its WACC?

c. Suppose now that there is not enough internal cash flow and the firm must issue new shares of stock. Qualitatively speaking, what will happen to the WACC? No numbers are required to answer this question.