Geralt Technologies is considering a major expansion program that has been proposed by the companys information technology group. Before proceeding with the expansion, the company need to develop an estimate of its cost of capital. Assume that you are an assistant to Henry Cavill, the financial vice-president. Your first task is to estimate Geralts cost of capital. Henry has provided you with the following data, which he believes may be relevant to your task:

(i) The firms tax rate is 40%.

(ii) The current market price of Geralts $1,000 par value, 12 percent coupon, semi-annual payment, non-callable bonds with 15 years remaining to maturity is $1,153.72. Geralt does not use short-term interest-bearing debt on a permanent basis.

(iii) The current price of the firms 10%, $100 par value, annual dividend, perpetual preferred stock is $111.10. The company would incur a issuing cost of 6%.

(iv) Geralts common stock is currently selling at $50 per share. Its last dividend was $4.19, and dividends are expected to grow at a constant rate of 5% in the foreseeable future. Geralts beta is 1.2, the yield on T-bonds is 7%, and the market risk premium is estimated to be 6%. For the bond-yield-plus-risk-premium approach, the firm uses a 4% point risk premium.

(v) Geralts target capital structure is 30% long-term debt, 10% preferred stock, and 60% common equity.

To structure the task somewhat, Henry has asked you to answer the following questions ( Without using financial Calculator ):

1 (a) What is Geralts overall, or weighted average, cost of capital (WACC). Use the cost of retained earnings as cost of common equity.

(b) Geralt is interested in establishing a new division, which will focus primarily on developing new Internet-based projects. In trying to determine the cost of capital for this new division, you discover that stand-alone firms involved in similar projects have on average the following characteristics:

Their capital structure is 40% debt and 60% common equity.

Their cost of debt is typically 12%.

The beta is 1.7.

Given this information, what would your estimate be for the divisions cost of capital? Note that Geralt uses the CAPM to calculate the divisions cost of capital.