The director of capital budgeting for See-Saw Inc., manufacturer of orthopedic surgery tools, is considering a plan to expand production facilities to meet an increase in demand. She estimates that this expansion will produce a rate of return of 10 percent. The firms target capital structure calls for a debt/equity ratio of 2/3. See-Saw currently has a bond issue outstanding that will mature in 20 years and has a 7.8 percent annual coupon rate. The bonds have a par value of $1,000 and are currently selling for $812.70. The firm has maintained a constant growth rate, E(g), of 7.4 percent. See-Saws most recent dividend, D₀was $2.2 and its current stock price, P₀is $35.80. Its tax rate is 25 percent. See-Saw is considering funding its expansion with debt only, and any new debt will have a 20 year maturity. The director has to determine whether See-Saw should undertake the expansion.

Note that the CCC sets the minimum return required on real-asset investments regardless of the actual financing anticipated during the planning period. That is, even if See-Saw planned to finance all new capital investments with debt financing, the appropriate cost of capital is the CCC. The rationale is that the debt financing cannot be obtained at the current cost rate without See-Saws equity bases, so from a financial perspective, the new capital investments are actually being financed using both equity and debt that is, being financed at the firms target capital structure.

Part a:

Estimate the cost of common equity using the DCF approach

Part b:

Estimate the cost of debt by the yield to maturity on the current debt

Part c:

Calculate the corporate cost of capital

Part d:

Assuming that the planned expansion of production facilities has the same risk as the average See-Saw project, should the project be undertaken? Please explain.