CASE 2

Suppose stock in William Corporation has a beta of 0.80. The market return is 12 percent, and the Treasury Bill rate is 6 percent. William's 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. William's target capital structure is 1/3 debt and 2/3 equity. Its cost of debt is 9 percent before taxes. Its tax rate is 21 percent.

Instructions:

a. What is William's cost of equity capital? Assume that you equally believe in the CAPM approach and the dividend growth model.

b. What is William's WACC?

c. William is seeking 30 million for a new project. The necessary funds will have to be raised externally. William's 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?

d. Under what circumstances would it be appropriate for William 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 division's cost of capital?