CASE 2 (30 points)

Suppose stock in Warren Corporation has a beta of 0.80. The market risk premium is 6 percent, and the risk-free rate is 6 percent. Warrens last dividend was 1.20 per share, and the dividend is expected to grow at 8 percent indefinitely. The stock currently sells for 45 per share. Warren has a target debt-equity ratio of 0.50. Its cost of debt is 9 percent before taxes. Its tax rate is 21 percent.

Instructions:

* a. What is Warrens cost of equity capital? Assume that you equally believe in the CAPM approach and the dividend growth model. (5 points)

* b. What is Warrens WACC? (5 points)

* c. Warren is seeking 30 million for a new project. The necessary funds will have to be raised externally. Warrens flotation costs for selling debt and equity are 2 percent and 16 percent, respectively. If flotation costs are considered, what is the true cost of the new project? (10 points)

* d. Under what circumstances would it be appropriate for Warren Corporation to use different costs of capital for its different operating divisions? What are two techniques you could use to develop a rough estimate for each divisions cost of capital? (10 points)