## Related questions with answers

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?

Solution

Verified**Given:**

$\begin{array}{l ll} \text{Current dividend per share }({\text{D}}_{\text{0}}) & = & \$2.20\\ \text{Growth rate (g) }& = & 6\%\\ \text{Price of common stock }({\text{P}}_{\text{0}}) & = & \$26.00\\ \text{Before-tax cost of debt }({\text{r}}_{\text{d}}) & = & 9\%\\ \text{Tax rate (T) }& = & 40\%\\ \text{Project A rate of return }& = & 12\%\\ \text{Project B rate of return }& = & 11\%\\ \end{array}$

$\textbf{Required:}$ a.) Cost of common equity $({\text{r}}_{\text{e}})$

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