Florida Electric Company (FEC) uses only debt and equity. It can borrow unlimited amounts at an interest rate of 8 percent as long as it finances at its target capital structure, which calls for 40 percent debt and 60 percent common equity. Its last dividend was $3, its expected constant growth rate is 3 percent, its stock sells at a price of $35, and new stock would net the company $30 per share after flotation costs. FEC’s marginal tax rate is 21 percent, and it expects to have $110 million of retained earnings this year. Two projects are available: Project A has a cost of $200 million and an internal rate of return of 13 percent, while Project B has a cost of $125 million and an internal rate of return of 8 percent.
All of the company’s potential projects are equally risky.
What is the cost of FEC’s retained earnings?
What is FEC’s cost of equity from newly issued stock?
What is FEC’s marginal cost of capital—that is, what WACC cost rate should it use to evaluate capital budgeting projects (these two projects plus any others that might arise during the year, provided the cost of capital schedule remains as it is currently)?