Question

Empire Electric Company (EEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of r_d = 9% as long as it finances at its target capital structure, which calls for 25% debt and 75% common equity. Its last dividend (D₀) was $2.45, its expected constant growth rate is 5%, and its common stock sells for $30. EEC's tax rate is 25%. Two projects are available: Project A has a rate of return of 15%, and Project B's return is 9%. These two projects are equally risky and about as risky as the firm's existing assets.

1. What is its cost of common equity? Do not round intermediate calculations. Round your answer to two decimal places.

     %

2. What is the WACC? Do not round intermediate calculations. Round your answer to two decimal places.

     %

3. Which projects should Empire accept?

Answer 1

Solution for part (a) & (b) is in the image uploaded while option (c) is written below:--

(c) WACC is often known as hurdle rate which is used for evaluating the new projects.A company entering new projects assuming similar risk can use WACC as a hurdle rate to decide whether it should enter into the project or not. WACC is the opportunity cost so while evaluating project ,a project having higher return than WACC is preffered over a project having lower return.

In this way Empire Electric Company (EEC) should select Project A as its expected return(15%) is higher than WACC(11.87%).