Star Appliances B
Star Appliance Company B
Executive Brief This proposal accounts for the new debt and equity mix of Star Appliances by estimating the company’s cost of equity. The methods used include the dividend discount model, the earnings/price model, and the CAPM model. After analyzing all three possibilities, it is apparent that the CAPM model provides the most accurate estimate of Star Company’s cost of capital because it accounts for the beta. Using the CAPM model, the new Star Company cost of equity is calculated as 9.4% and the WACC is determined to be 9.14% at the 9.5% debt rate. In addition to the estimation of the cost of equity, Star Appliance Company is also considering increasing their current debt ratio of 9.5% to the industry average of 19%. With a higher current debt ratio the WACC will be lower, at a rate of 8.24%. The cost of equity of each product was valued using the beta from the industry averages. The beta of the home appliance industry is 0.95, while the beta of the agricultural machinery industry is 0.88. Through the use of the CAPM model, these betas yield a cost of equity for the home appliances of 11.29% and for the agricultural machinery of 10.7%. The WACC of each individual project is then compared to the project’s IRR. The WACC of the home appliance project was found to be 10.4% and the WACC of the agricultural machinery project was calculated as 9.92%, while the IRR’s of the appliance and agricultural machinery projects were 11.29% and 10.7%, respectively. Therefore, both projects should be accepted based on the notion that the internal rate of return of each project is greater than the weighted average cost of capital. It is recommended that Star Appliance Company determine a new WACC at the 9.5% debt ratio, determine each project’s cost of equity and WACC, and accept both projects in conclusion.
Introduction
In 1982 Star Appliance expanded its business by purchasing Rhinescour Company, which added to Star’s long-term debt for the
Executive Brief This proposal accounts for the new debt and equity mix of Star Appliances by estimating the company’s cost of equity. The methods used include the dividend discount model, the earnings/price model, and the CAPM model. After analyzing all three possibilities, it is apparent that the CAPM model provides the most accurate estimate of Star Company’s cost of capital because it accounts for the beta. Using the CAPM model, the new Star Company cost of equity is calculated as 9.4% and the WACC is determined to be 9.14% at the 9.5% debt rate. In addition to the estimation of the cost of equity, Star Appliance Company is also considering increasing their current debt ratio of 9.5% to the industry average of 19%. With a higher current debt ratio the WACC will be lower, at a rate of 8.24%. The cost of equity of each product was valued using the beta from the industry averages. The beta of the home appliance industry is 0.95, while the beta of the agricultural machinery industry is 0.88. Through the use of the CAPM model, these betas yield a cost of equity for the home appliances of 11.29% and for the agricultural machinery of 10.7%. The WACC of each individual project is then compared to the project’s IRR. The WACC of the home appliance project was found to be 10.4% and the WACC of the agricultural machinery project was calculated as 9.92%, while the IRR’s of the appliance and agricultural machinery projects were 11.29% and 10.7%, respectively. Therefore, both projects should be accepted based on the notion that the internal rate of return of each project is greater than the weighted average cost of capital. It is recommended that Star Appliance Company determine a new WACC at the 9.5% debt ratio, determine each project’s cost of equity and WACC, and accept both projects in conclusion.
Introduction
In 1982 Star Appliance expanded its business by purchasing Rhinescour Company, which added to Star’s long-term debt for the