Suppose stock in Babolat Corporation has a beta of 0.80. The market risk premium is 6%, and the risk-free rate is 6%. Babolats last dividend was 1.20 per share, and the dividend is expected to grow at 8% indefinitely. The stock currently sells for 45 per share. Samsung has a target debt-equity ratio of 0.50. Its cost of debt is 9%. Please ignore taxes for the purpose of this exercise.

Instructions:

1. What is Babolats cost of equity capital? Assume that you equally believe in the CAPM approach and the dividend growth model.

2. What is Warrens WACC?

3. Babolat is seeking 30 million for a new project. The necessary funds will have to be raised externally. Babolats flotation costs for selling debt and equity are 2% and 16%, respectively. If flotation costs are considered, what is the true cost of the new project?

4. Under what circumstances would it is appropriate for Babolat 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?