3. [15 Points] To cope with the recent elevated demand for baking goods, Basque Cheesecake Co. plans to raise capital to build a new our factory. The market value of the company's debt is $28 million and has a yield to maturity of 12%. The company pays a corporate tax of 30%. The company's preferred stock is worth $22 million in total. The preferred stock pays a $3 annual dividend per share. The current price of the preferred 3 MGMT 6170 stock is $25 per share. There is a otation cost of 20% of the selling price for issuing new preferred stocks. There are currently 1.2 million common shares outstanding. The current price of the common shares is $25 per share. The common equity will be raised internally using retained earnings. Its current equity beta is 2. The market expected return is 10% and the risk-free rate is 2%.

(a) What are flotation costs? Why do they matter in cost of capital estimation?

(b) What is the weighted average cost of capital (WACC) for the new project? Assume the current capital structure is optimal and will be used as the target capital structure.

(c) Consider three capital budgeting criteria: net present value (NPV), internal rate of return (IRR), and modied internal rate of return (MIRR), and explain how WACC information is used in the capital budgeting procedure. Specically, answer the two questions below: i. Do you need WACC when you estimate the three above-mentioned capital budgeting measures? ii. Do you need WACC when making capital budgeting decisions per the three criteria?