The Financial Assignment
1) Why do you think Larry Stone wants to estimate the firm’s hurdle rate? Is it justifiable to use the firm’s weighted average cost of capital as the divisional cost of capital? Please explain. Larry Stone wants to calculate the firm’s hurdle rate because he wants to have a more reliable basis of information before accepting projects for the company. By determining the firm’s hurdle rate, their company will also be able to make prudent decisions using accurate data. He also thinks that they should not just rely on their “gut feel” because in the future, they won’t be as lucky as they are as of the moment.
In our opinion, it is justifiable to use the firm’s weighted average cost of capital as the divisional cost of capital. If the projects of the different divisions have similar risk, this means that it’s okay to use the WACC as divisional cost of capital. If there are different risks, the cost of capital within the same firm needs to be established.
2) How should Stephanie go about figuring out the cost of debt? Calculate the firm’s cost of debt.
There are actually two steps involved in calculating Oceanic’s cost of debt. The first step cites the determination of the firm’s yield to maturity to be used as the value representing the Before-Tax Cost of Debt. Subsequently, we can apply it in order to compute for the After-Tax Cost of Debt, which constitutes the next step.
Step 1: Calculation of the Yield to Maturity (Estimated)
=100 +(1000-915)/25(1000+915)/2 =10.80% / 11%
Step 2: Calculation of the After-Tax Cost of Debt =.11 1-.34 =7.26%/ 7%
3.) Comment on Stephanie’s assumptions as stated in the case. How realistic are they?
Initially, most of Stephanie’s assumptions can genuinely be considered realistic. However, there are still few of them that need to be reviewed as there are certain factors that ought to be considered before confirming the realism of those assumptions.
Starting with those assumptions that
In our opinion, it is justifiable to use the firm’s weighted average cost of capital as the divisional cost of capital. If the projects of the different divisions have similar risk, this means that it’s okay to use the WACC as divisional cost of capital. If there are different risks, the cost of capital within the same firm needs to be established.
2) How should Stephanie go about figuring out the cost of debt? Calculate the firm’s cost of debt.
There are actually two steps involved in calculating Oceanic’s cost of debt. The first step cites the determination of the firm’s yield to maturity to be used as the value representing the Before-Tax Cost of Debt. Subsequently, we can apply it in order to compute for the After-Tax Cost of Debt, which constitutes the next step.
Step 1: Calculation of the Yield to Maturity (Estimated)
=100 +(1000-915)/25(1000+915)/2 =10.80% / 11%
Step 2: Calculation of the After-Tax Cost of Debt =.11 1-.34 =7.26%/ 7%
3.) Comment on Stephanie’s assumptions as stated in the case. How realistic are they?
Initially, most of Stephanie’s assumptions can genuinely be considered realistic. However, there are still few of them that need to be reviewed as there are certain factors that ought to be considered before confirming the realism of those assumptions.
Starting with those assumptions that