Midwest Electric Company (MEC) uses only debt and common equity. It can borrow unlimited amounts at an

Question:

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 45% debt and 55% common equity. Its last dividend 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%, while 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?

Common Stock
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