Kellogs
According to the text, the initial costs for this project is $15 868 000 and in order to generate the Return on Investment, Jeff Wiemann decided to consider the useful life of the project to be 5 years (n=5). 1. What is the appropriate discount rate for a government agency such as the San Diego City Schools?
WACC calculation (estimation)
WACC = cost of debt + cost of equity (weighted by the % of debt/equity in the capital stack)
Though we do not know the precise numbers specific to SDCS at that time, we can make some generalizations.
Cost of debt = interest rate of a school bond
Typically these types of bonds are voted for (approved) and paid back by the local community (known as voted indebtedness); payments are collected with property taxes
Typically these bonds bear very low nominal interest rates (usually just a CPI adjustment) since the voters are the ones who bear the interest (does not make sense for them to issue themselves a high-interest rate loan)
If the bonds are sold in the open market, they are considered low-risk, thus bondholders do not require a high interest rate
Approx. risk-free rate at time of the case (2002) (US 10-year T-Bill ) = 5%
Approx. school bond rate at time of the case (2002) (link ) = 5%
Cost of equity = expected return of equity investments
Equity in this case is provided via tax revenue (probably a mixture of local, state and federal sources)
The median income of San Diego City at the 2000 Census was measured at about $46,000
The estimated tax rate for this income bracket is estimated at 9.3%
Cost of equity is 9.3%
Weighted average: debt to equity ration approximately 60:40 (based on the balance sheet on page 21 of this report )
Weighted average = 8.7%
Why not use a relative scale?
Must not arbitrarily adjust for risks otherwise the decision analysis is dubious
2. Calculate the ROI for San Diego's ERP system. How can you quantify the soft benefits of the system and include them in the analysis? Assumptions:
WACC calculation (estimation)
WACC = cost of debt + cost of equity (weighted by the % of debt/equity in the capital stack)
Though we do not know the precise numbers specific to SDCS at that time, we can make some generalizations.
Cost of debt = interest rate of a school bond
Typically these types of bonds are voted for (approved) and paid back by the local community (known as voted indebtedness); payments are collected with property taxes
Typically these bonds bear very low nominal interest rates (usually just a CPI adjustment) since the voters are the ones who bear the interest (does not make sense for them to issue themselves a high-interest rate loan)
If the bonds are sold in the open market, they are considered low-risk, thus bondholders do not require a high interest rate
Approx. risk-free rate at time of the case (2002) (US 10-year T-Bill ) = 5%
Approx. school bond rate at time of the case (2002) (link ) = 5%
Cost of equity = expected return of equity investments
Equity in this case is provided via tax revenue (probably a mixture of local, state and federal sources)
The median income of San Diego City at the 2000 Census was measured at about $46,000
The estimated tax rate for this income bracket is estimated at 9.3%
Cost of equity is 9.3%
Weighted average: debt to equity ration approximately 60:40 (based on the balance sheet on page 21 of this report )
Weighted average = 8.7%
Why not use a relative scale?
Must not arbitrarily adjust for risks otherwise the decision analysis is dubious
2. Calculate the ROI for San Diego's ERP system. How can you quantify the soft benefits of the system and include them in the analysis? Assumptions: