WACC Midwest Electric Company (MEC) uses only debt and common equity. It can bor
ID: 2765730 • Letter: W
Question
WACC Midwest Electric Company (MEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of rd = 10% as long as it finances at its target capital structure, which calls for 25% debt and 75% common equity. Its last dividend (D0) was $1.50, its expected constant growth rate is 5%, and its common stock sells for $22. MEC's tax rate is 40%. Two projects are available: Project A has a rate of return of 14%, while Project B's return is 10%. These two projects are equally risky and about as risky as the firm's existing assets. What is its cost of common equity? Round your answer to two decimal places. % What is the WACC? Round your answer to two decimal places.
Explanation / Answer
Cost of Common equity:
Cost of equity refers to a shareholder's required rate of return on an equity investment. It is the rate of return that could have been earned by putting the same money into a different investment with equal risk
Formula:
Cost of Equity = (Next Year's Annual Dividend / Current Stock Price) + Dividend Growth Rate
Cost of equity = ($1.5(1.05)) / $22) + 5%
Cost of equity = ($1.575 / $22) + 5%
Cost of equity = 0.0715 + 0.05
Cost of equity = 0.1215 or 12.15
Calculation of WACC:
Particulars
Cost of equity / debt
Weights
WACC
Equity
12.15%
75%
9.11
Debt
6%
25%
1.50
WACC
10.61
WACC = 10.61%
Calculation of WACC:
Particulars
Cost of equity / debt
Weights
WACC
Equity
12.15%
75%
9.11
Debt
6%
25%
1.50
WACC
10.61
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