(Divisional costs of capital and investment decisions?) In Mayof this year Newcastle Mfg.? Company's capital investment reviewcommittee received two major investment proposals. One of theproposals was put forth by the? firm's domestic manufacturing?division, and the other came from the? firm's distribution company.Both proposals promise internal rates of return equal toapproximately 14 percent. In the? past, Newcastle has used a singlefirm wide cost of capital to evaluate new investments.?? ?However,managers have long recognized that the manufacturing division issignificantly more risky than the distribution division. In? fact,comparable firms in the manufacturing division have equity betas ofabout 1.7?, whereas distribution companies typically have equitybetas of only 1.1. Given the size of the two? proposals,Newcastle's management feels it can undertake only? one, so itwants to be sure that it is taking on the more promisinginvestment. Given the importance of getting the cost of capitalestimate as close to correct as? possible, the? firm's chieffinancial officer has asked you to prepare cost of capitalestimates for each of the two divisions. The requisite informationneeded to accomplish your task? follows:

The cost of debt financing is 9 percent before taxes of 33percent. You may assume this cost of debt is after any flotationcosts the firm might incur.

The? risk-free rate of interest on? long-term U.S. Treasurybonds is currently 7.5 ?percent, and the? market-risk premium hasaveraged 4.1 percent over the past several years.

Both divisions adhere to target debt ratios of 50 percent.

The firm has sufficient internally generated funds such that nonew stock will have to be sold to raise equity financing.

a. Estimate the divisional costs of capital for themanufacturing and distribution divisions.

b. Which of the two projects should the firm undertake?(assuming it cannot do both due to labor and other nonfinancial?restraints)? Discuss.