PROBLEM 4 Weighted Average Cost of Capital

Flatbush Bagels wants to determine its Weighted Average Cost of Capital (WACC) for budgeting purposes. You have learned:

The firms non-callable bonds mature in 5 years, have an 8% annual coupon and a par value of $1,000. The bonds sell at a premium of $1025.00.

The companys tax rate is 25%.

The stock trades at $30.00. It just paid an annual dividend of $2.00 per share and the market believes that the firms dividend growth rate will remain constant at 2.00% annually

The target capital structure is 45% and 55% common equity.

(a) What is Flatbush Bagels weighted average cost of capital?

(b) Suppose that the firm is considering a project to open several stores that also roast coffee and sell breakfast sandwiches. This type of operation will expand the business into new areas and markets, but is also riskier than the core bagel baking operation. What can the managers do when calculating the NPV or MIRR of the expansion project in order to account for the additional level of risk?