Question

Division of capital and investments in May of this year Newcastle Mg Company's cap investment review committee received two major investment proposals. One of the propos was put fort by the domestic manufacturing division, and the other came from the firm's distribution company Both proposals promise nemal rates of return equal to approximately 15 percent. In the past, Newcastle has used a single firm wide cost of capital to evaluate new investments However, managers have long recognized that the manufacturing division is significandy more than the distribution division in fact, comparable in the manufacturing division have equity betas of about 1 whereas distribution companies typically have equity betas of only 1.2. Given the size of the two proposals, Newcastle's management feels it can undertake only one, so it wants to be sure that it is taking on the mor promising investment. Given the importance of getting the cost of capital estimate as close to correct as possible, the firm's chief financial officer has asked you to prepare cost of capital estimates for each of the two divisions. The requisite information needed to accomplish your task follows • The cost of debt financing is percent before taxes of 34 percent. You may assume this cost of debt is ahor any fotation costs the firm might incur • The free rate of interest on long term US Treasury bonds is currenty 6.7 percent, and the market risk premium has averaged 48 percent over the past several years . Both divisions adhere to target tos of 40 percent The firm has continmal generated funds such an new stock will have to be sold origuity financing Estimate the divisional cost of capital for the manufacturing and distribution divisions Which of the words should the firm undertake assuming it cannot do both due to labor and other non financial restraints? Discuss

Answer 1

SEE THE IMAGE. ANY DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

IMAGE WAS BLUR, SO JUST CHECK I READ CORRECTLY, COST OF DEBT = 8%, BETA OF MANUFACTURING FIRM = 1.8 AND THAT OF DISTRIBUTION FIRM =1.2

ke - Microsoft Excel (Product Activation Failed) Add-Ins File Home Insert Page Layout Formulas Data Review View - 2x % Cut A = = = V General A A Wrap Text FMerce Merge & Center - Center E E E s $ -% % 4.0 .00 . Insert Delete Format Conditional Format Formatting as Table Styles Cell Styles Σ AutoSum : A Fill Sort & 2 Clear Filter Editing Find & Select Alignment Number Cells Calibri 11 E Copy Paste Format Painter B I U B- Clipboard Font KZ103 KT KU KVKW 102 103 MANUFACTURING DIVISION 104 COST OF EQUITY ke = Rf + beta(Rm-Rf) KX KY K Z LA LB LC LD LE LE LE LG LH LI DISTRIBUTION DIVISION COST OF EQUITY ke = Rf + beta(Rm-Rf) 105 Rf = RISK FREE RATE = 6.7%, Rm-Rf = 4.8% beta = 1.8 Rf = RISK FREE RATE = 6.7%, Rm-Rf = 4.8% beta = 1.2 106 107 108 109 ke =6.7% + 1.8*(4.8%) = 15.34% ke =6.7% + 1.2* (4.8%) = 12.46% 110 COST OF DEBT AFTER TAX (SAME FOR BOTH COMPANIES) COST OF DEBT AFTER TAX = 8%(1-0.34) = 5.28% 111 112 113 114 115 116 117 118 119 120 121 WACC FOR MANUFACTURING COMPANY SOURCE WEIGHTS COC (%) WEIGHTED COST DEBT 40% 5.28% 2.11% EQUITY 60% 15.34% 9.20% WACC 11.32% WACC FOR DISTRIBUTION COMPANY SOURCE WEIGHTS COC (%) WEIGHTED COST DEBT 40% 5.28% 2.11% EQUITY 60% 12.46% 7.48% WACC 9.59% ANS a ANS b WACC FOR MANUFACTURING DIVISION = 11.32% AND FOR DISTRIBUTION DIVISION = 9.59% DISTRIBUTION PROJECT SHOULD BE SELECTED : BECAUSE COST OF CAPITAL IS LOWER & THUS HIGHER NPV 122 R M convexity DGM betaport future INDEX INTL CAP BUD LEASING PV, FV, ANNUITY DIR right clean YIELD bond portfolio KE CAPM UTILITY, SHARPE, beta ferences: CF135 cap stru WACC BOJ 120% RESI el O Rea DO 4 * 4 OENG 19-11-2019