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1/15/2015
Lex Ser vi ce PLC – Cost of Capi tal
Lex Service PLC – Cost of Capital * Required
WACC What is Debt / Equity ratio used by you in estimating WACC for Property Division? 1.30
What are the issues involved in using multiple WACC? If multiple WACC rates are used, multiple observations are required for the calculation of beta and risk premiums. It is not always possible to estimate division beta of a firm as it is not traded on the open markets and thus the cost of equity is difficult to determine.
Why contract hire is shown with higher level of leverage? The contract hire is in joint venture with Lombard North Central PLC which is a part of the National Westminster Bank. While Lex is responsible for the daily operations, Lombard provides the funding for the fleet which is provided by the bank in the form of debt. Thus, there is a higher level of leverage.
How you estimated Lex Services Cost PLC consolidated corporate cost of capital and how such estimates should be used? * The consolidated corporate cost of capital was estimated using the target D/E ratios for individual divisions. The weighted WACC for the divisions is used for calculating the firm WACC. Another approach that can be used is to find the beta for the firm using the weighted betas of the divisions. This value is used to find the cost of equity and then the WACC.
What is Debt / Capital ratio used by you in estimating WACC for Contract Hire Division? 77.4
If you can justify a different risk-adjusted discount rate for each division, then why not for each business unit within a division, or each project within a unit, or each separately identifiable stream of cash within a project? http ttps:// s://d docs.g cs.google.c le.co om/a m/a/ast /astra ra.x .xlri. lri.a ac.in c.in/f /fo orms/d rms/d/1_ /1_D_Jd D_Jd4 4LNDT_UK NDT_UK4 42a1onhXmPD XmPDrvRjA rvRjAyp ypsrCll srClliHso iHsowb wbE/ E/fo formRe rmResp spo onse
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1/15/2015
Lex Service PLC – Cost of Capital
This is theoretically possible but implementing it practically is not feasible as every stream will have a different beta and different risk premium. Estimating beta for individual stream is not possible as they are not publicly traded or do not have a benchmark against which they can be compared.
Whether Lex Services PLC should employ a single cost of capital as a hurdle rate for all projects throught the company, or multiple cost of capital estimates, one for each major division? If the risk profile of the division is similar to the overall firm then the same hurdle rate can be used. But if the risk profile of a project (especially a new one) is different from the firm, then multiple hurdle rates have to be used.
What type of weights you used in estimating WACC? Book Value
Market Value
Target Value
Lex Services PLC Contract Hire Automotive Distribution Division Property
What is Debt / Capital ratio used by you in estimating WACC for Lex Services PLC? 0.1525
Why would the company ever accept a project with, say, a 10.5% rate of return that meets that division’s lower hurdle rate while turning down a project with a higher expected return (e.g. 12%) that might be just below its division’s higher hurdle rate? Won’t multiple rates of return drive capital to the low-return businesses, thus turning Lex Services PLC into a lowreturn company? Acc epting a lower rate then the higher hurdle rate would definitely bring down the overall return of the business. But the increasing weight of such projects would eventually bring down the hurdle rate of the firm and then such projects would help to make profit at a lower risk.
What could cause change in WACC for Lex Service PLC across time? https://docs.google.com/a/astra.xlri.ac.in/forms/d/1_D_Jd4LNDT_UK42a1onhXmPDrvRjAypsrClliHsowbE/formResponse
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Lex Service PLC – Cost of Capital
The increase in risk of the project undertaken can lead to an increase in the expected return which increase the cost of equity and thus the WACC. Also, increasing levels of debt and equity can lead to higher expected returns. This is the underlying principle of Marginal Cost of Capital (MCC).
What is Debt / Capital ratio used by you in estimating WACC for Property Division? 0.565
What is your assumed beta for Debt in estimation of WACC? 0
Lex doesn’t fund itself at the divisional level (except for contract hire), and its equity investors posses a claim on the whole company. So why accept any rate of return other than the overall corporate-wide cost of capital? The rate of return on a new project might be different from the overall cost of capital as the risk structure for the project might be different. If firm wide cost of capital is used in this case, we might reject a good proposal or accept a bad proposal.
What is Debt / Capital ratio used by you in estimating WACC for Automotive Distribution Division? 0.1304
Describe the process followed by you in estimating WACC for the firm and the division? The following steps were followed: 1. The cost of equity is computed using the CAPM model. The value of beta used for the division is levered from the unlevered beta value provided in the case. In case of the firm, the value provided in the case is directly used. To lever the beta, the midpoint value of target D/E ratio is used. 2. The cost of debt is the standard value provided in the case. It is taken to be same for both the firm and the divisions.
What is Debt / Equity ratio used by you in estimating WACC for Contract Hire Division? 4.89
Is there a Bias in the Estimate of Lex’s Cost of Capital?
Lex's cost of capital uses the beta provided in the case for calculating the consolidated firm WACC. This is erroneous as the capital structure of the firm is not taken into account in this method. This can be rectified using the weighted beta approach wherein the beta for all the division is taken into account or by using the weighted WACC approach.
What is Debt / Equity ratio used by you in estimating WACC for Lex Services PLC? 0.18
What is Debt / Equity ratio used by you in estimating WACC for Automoive Distribtuion Division? 0.15
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