case 90 Essay

Submitted By Stephen-McDaniel
Words: 1417
Pages: 6
Open Document
QUESTIONS

28 total question / 4 – 7 questions each.

1. Explain the importance of risk adjustment in the capital budgeting allocation process by answering the following questions.
a. Explain why risk adjustments are important and how they can affect firm value.

Risk adjustments are important because if they are not used than expectations for projects will be unrealistic. It is necessary to use risk adjustments because you may accept a high risk project that should have been rejected which could affect the firm’s value. This could also cause the firm to improperly budget a project and run out of money before the project before it is finished. Therefore, this could have a negative effect on the firms stock and also cause embarrassment to the company.

b. Explain how the single hurdle rate currently used by Northern Forest Products can change the risk structure of the company. For example, think about what would happen if the Plastic Products Division received a disproportionately high level of funding because their returns exceed the company hurdle rates (its growth rate substantially exceeds the corporate average). Assuming that the risk of the division remains unchanged, what effect would this have, over time, on NFP’s corporate beta and on the overall cost of capital?

This will increase the corporate beta, and it will also increase the cost of capital for the corporation. The beta for the Plastic Products Division is higher than the corporation’s beta. This means if they receive a higher level of funding than the cost of equity for the division will increase because they will be investing more in their assets. If the cost of equity increases in a division with a higher beta than they should assume the corporate beta will increase long with cost of capital.

2. Explain the rationale behind using beta as a measure of risk. .

Beta is important to use as a measure of risk because it measures the risk that cannot be diversified away.

Compute the company’s beta based on the divisional betas and compare it with that provided by ValueLine and Merrill Lynch. Explain some of the inconsistencies that can be found in reported betas. Do historical betas provide good measures of the future riskiness of firms (or divisions)?

The company’s beta calculated in the spreadsheet is 1.06. ValueLine reported the company’s beta at 1.04 while Merrill Lynch reported it at 1.12. The inconsistent reported betas can result from both companies using historical betas. Historical betas are not good measurements of the future riskiness of firms. This is because they use historical returns and do not account for recent market volatility.

3. Using the computed beta, find the cost of equity, the weighted average cost of capital
(WACC), and the hurdle rate for the company. Discuss the negative impact of the added premium to the cost of capital.

Cost of equity = 14.65%
WACC = 11.77%
Hurdle Rate = 15.77%

The negative impact of the added premium is that it causes the company to pass up on projects that could benefit the shareholders. But by breaking the hurdle rate down for each division it should help capture these projects.

4. Compute the cost of equity for each of the company’s divisions.

Then, compute the WACC and the hurdle rates for each division, assuming that all divisions use a 42 percent debt ratio.

Division
Beta
Equity
WACC
Hurdle rate
Paper product
1.12
15.12%
12.05%
16.05%
Timber product
0.98
14.05%
11.42%
15.42%
Wood product
0.82
12.81%
10.71%
14.71%
Plastic products
1.28
16.36%
12.76%
16.76%
Real estate
1.43
17.51%
13.43%
17.43%

5. Do you agree with Betty concerning the capital structure issue?

Discuss several arguments that Betty can use to help justify using the company rather than divisional capital structure to determine WACC.

Yes, I agree with the capital structure. She could point out that using the expanding to quickly could spread them too thin which would result in drops in bond ratings and lost earnings because
Show More

Related Documents: case 90 Essay

Case 90 Questions Essay example

QUESTIONS 1. Explain the importance of risk adjustment in the capital budgeting allocation process by answering the following questions. a. Explain why risk adjustments are important and how they can affect firm value. Without the correct risk adjustment the firms stock will lose value by taking on high risk projects. The firm could also be considered uncompetitive if they reject low cost/low risk projects. b. Explain how the single hurdle rate currently used by Northern Forest Products can change…

Words 1434 - Pages 6

Sol 6-90: A Case Study Of Mark Watney

In sol 6-90, I see a lot of persistence from Mark Watney. Mark definitely remains focused and looks for ways to reach goals while stuck. First off, he's literally stuck, stuck on mars! If any other person were stuck in mars , they would definitely go insane. But, Mark is really goal oriented and has the ability to power through challenges that he is faced with. Mark is able to stay persistent while faced with challenges such as establishing fertile soil for growing potatoes on Mars, thinking…

Words 667 - Pages 3

Assignment 1 Essay

eventually sold. The building which ABC is eyeing has 400 apartments which have been on rent for several years. The building is close to subway station, universities, shopping malls, grocery stores and parks which make it attractive venue. Thereby achieving 90-100% utilization on the rental apartments will not be daunting task for ABC’s experienced sales and marketing staff. The building currently has renters which have annual leases. Since ABC is targeting to sell the building after 5 years, the plan is…

Words 2350 - Pages 10

Big Time Toymaker Case Study

Case Scenario: Big Time Toymaker (BTT) A contract is an agreement between two parties that is enforceable in court. A verbal and/or written becomes valid when there has been a promise, an acceptance, and consideration relating to the terms of the agreement. At any point, a binding contract is breached, “the law provides certain relief for aggrieved parties that suffer losses as a result of another’s party breach of contract” (Melvin, 2011). Therefore, non-breaching party may be awarded with remedies…

Words 864 - Pages 4

econ Essays

Microeconomics Homework Problem 1: C(Q) = 100 + 20Q + 15Q^2 + 10Q^3 a) Fixed Cost (doesn’t change depending on output produced) = 100 b) Variable Cost of producing Q = 10 units: 20*10 + 15*10^2 + 10*10^3 = 200 + 1,500 + 10,000 = 11,700 c) Total Cost of producing Q = 10 units: C(10) = 100 + 20*10 + 15*10^2 + 10*10^3 = 11,800 Alternatively, we have Total Costs of Producing Q=10 units = Fixed Costs + Variable Costs of producing Q = 10 units = 100 + 11,700 = 11,800 d)…

Words 1244 - Pages 5

Case Review: Wards Cove Parking V. Antonia

or white. The Smartest got in. The courts cases of the 80’s and 90’s created sharp differences between the views sought out on many courts cases. Some decisions were consistent with the opinion of US citizens and some were the complete opposite. Some decisions strengthened fundamental principles Other decisions, notably near the end of the 1980s, created uncertainties that could only be addressed through Congressional action. Many of the court cases seen in the…

Words 636 - Pages 3

Rugby: Sampling Method Essay

think (a) Anna and (b) Robert might actually be using? Explain why? Anna decided to choose systematic sampling, which I think, is a good choice. I think this because it selects random people even if they are not related to the task, which in this case is school letter-headed notepaper or a school calendar. However by choosing this type of sampling it takes a more time because you choose a 1-10 out of everyone in the whole school, which takes a lot of time and effort to do. Robert chooses to use…

Words 429 - Pages 2

Case Scenario: Big Time Toymaker

Case Scenario: Big Time Toymaker LAW/421 Case Scenario: Big Time Toymaker Big Time Toymaker (BTT) develops, manufactures, and distributes board games and other toys in North America, Chou is the inventor of a new strategy game he calls Strat. BTT had an interest in distributing Strat and entered into an agreement with Chou, offering him $25,000 in exchange for exclusive negotiation rights for a 90-day period. This agreement stipulated that no distribution contract existed unless it was in writing…

Words 2111 - Pages 9

Merton Electronics Case Essay

Merton Electronics Case Study 1) Merton Electronics is subject to transaction exposure. Transaction exposure is the gains or losses realized from the settlement of specific transactions that are denominated in a foreign currency. There are two main types of transaction exposure: 1) Purchasing or selling on credit goods denominated in a foreign currency 2) Borrowing or lending funds when repayments is going to be made in foreign currency. In respects to Merton’s Yen payments they are subject…

Words 1278 - Pages 6

Essay on Acct505 Case Study 1

November 16, 2014 Charisma Watkins Managerial Accounting Case Study 1 Springfield Express is a luxury passenger carrier in Texas. All seats are first class, and the following data are available: Number of seats per passenger train car 90 Average load factor (percentage of seats filled) 70% Average full passenger fare $ 160 Average variable cost per passenger…

Words 779 - Pages 4