Harvard Business School
Rev. March 13, 1998
Lex Service PLC—Cost of Capital
On November 25, 1993, the directors of Lex Service PLC, received a memorandum from G. Lionel Harvey, the company’s deputy chief executive, concerning the approaching board meeting on December 2. Attached to the memo was a report by the L.E.K. Partnership, a London-based consulting firm, concerning Lex’s cost of capital. The report and its implications for management were to be discussed at this board meeting.
Recent developments at Lex had focused top management’s attention on the company’s capital budgeting procedures and its cost of capital. Between 1991 and 1993, various sales of subsidiaries and other assets had provided Lex with more than £340 million of funds. During this same period, approximately £132.5 million of this amount had been used to pay for a string of new acquisitions in the automotive distribution and leasing businesses.1 Since Lex employed discounted cash flow analysis to help evaluate the worth of its investment opportunities, the question of what rate of return to demand on its investments had come squarely to the forefront as it implemented its acquisition program.
At the time of its public incorporation in 1928, what was then known as Lex Garages Limited consisted of a single garage located on the corner of Lexington and Brewer streets in London. More than 60 years later, Lex Service PLC had become the leading company in automotive distribution and leasing in the United Kingdom. In 1992, Lex earned £90 million on total revenues of £911 million, and had total assets of £420 million. In 1993, the company expected to earn in excess of £80 million on revenues of approximately £1.2 billion. Recent financial statements are provided in Exhibits 1 and 2. Originally an operator of a small group of parking garages and petrol stations, in 1945 Lex began to expand its automotive activities through a series of acquisitions of companies holding distribution franchises for various British, European, and American car manufacturers. Perhaps the most significant acquisition was made in the late 1950s, when Lex obtained from the Volvo Car Corporation the exclusive franchise to import and distribute Volvo cars in the United Kingdom. Over
1.Most of the balance was used to repay about £197 million of debt, leaving the company with very little financial leverage as it approached the end of 1993.
Professor W. Carl Kester and Research Associate Kendall Backstrand prepared this case as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 1996 by the President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, MA 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—without the permission of Harvard Business School.
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Lex Service PLC—Cost of Capital
the next few decades this importership came to be regarded as one of the ultimate success stories within the U.K. automotive industry. In the early 1970s, Lex began to diversify into other service businesses in the United Kingdom, marking its second series of acquisitions. These areas of business included transportation and leasing, as well as hotel management from which it subsequently withdrew.
After Britain’s 1973-1974 economic recession, however, Lex realized the dangers of its sole dependence on local markets and launched an international diversification strategy. Lex forecasted attractive...
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