Midwest Electric Company (MEC) uses only debt and common equity. It can borrow u
ID: 2733733 • Letter: M
Question
Midwest Electric Company (MEC) uses only debt and common equity. It can borrow unlimited amounts at an interest rate of rd = 9% as long as it finances at its target capital structure, which calls for 40% debt and 60% common equity. Its last dividend (D0) was $1.55, its expected constant growth rate is 6%, and its common stock sells for $25. MEC's tax rate is 40%. Two projects are available: Project A has a rate of return of 10%, while Project B's return is 8%. 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.
Explanation / Answer
Cost of common equity ( As per Gordon Growth model )
R = D0 * ( 1 + G) / Price + G = 1.55 * ( 1 + 6%) / 25 + 6% = 12.57%