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Predators is a multi-divisional firm involved in a number of infrastructure related projects spanning construction, engineering design, and power transmission. To finance its growth during

Predators is a multi-divisional firm involved in a number of infrastructure related projects spanning construction, engineering design, and power transmission. To finance its growth during this period of high government spending, new stocks and bonds can be issued in any amount. New bonds would pay a 6% annual coupon rate and incur floatation costs totaling 1.5% of the amount issued, while new equity would face floatation costs totaling 8% of the amount issued. Covenants on the firm's existing bonds limits it to a maximum debt/equity ratio of 0.8 and its tax rate is 30%.

Since the company is involved with a number of different projects, your supervisor has asked you to estimate the appropriate weighted average cost of capital for the construction division by benchmarking to two comparable construction companies.

Diggem Inc: this year's dividend = $1.65, sustainable dividend growth = 6%, stock price = $18.45, D/E = 0.6, tax rate = 25%, KD = 6% (pre-tax)

Skyreach Inc: Beta = 1.7, D/E = 0.9, Risk-free rate = 2%, expected market return = 10.65%, tax rate = 20%, KD = 8% (pre-tax)

Assuming an absence of distress costs, that debts have an approximately zero Beta, and that the firm targets a debt/equity ratio of 0.80 (its maximum allowed), what will be its cost of capital for a $14 million dollar project in the construction division assuming it has sufficient retained earnings to avoid issuing new shares?

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