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LexServicePLCCostofCapital
WACC
What is Debt / Equity ratio used by you in estimating WACC for Property Division?
1.30
How you estimated Lex Services Cost PLC consolidated corporate cost of capital and how
such estimates should be used? *
Theconsolidatedcorporatecostofcapitalwasestimatedusingthe
targetD/Eratiosforindividualdivisions.TheweightedWACCforthe
divisionsisusedforcalculatingthefirmWACC.
Anotherapproachthatcanbeusedistofindthebetaforthefirm
usingtheweightedbetasofthedivisions.Thisvalueisusedtofind
thecostofequityandthentheWACC.
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?
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Thisistheoreticallypossiblebutimplementingitpracticallyisnot
feasibleaseverystreamwillhaveadifferentbetaanddifferentrisk
premium.Estimatingbetaforindividualstreamisnotpossibleas
theyarenotpubliclytradedordonothaveabenchmarkagainst
whichtheycanbecompared.
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?
Iftheriskprofileofthedivisionissimilartotheoverallfirmthenthe
samehurdleratecanbeused.Butiftheriskprofileofaproject
(especiallyanewone)isdifferentfromthefirm,thenmultiplehurdle
rateshavetobeused.
Market Value
Target Value
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 divisions lower hurdle rate while turning down a project with a higher expected return
(e.g. 12%) that might be just below its divisions higher hurdle rate? Wont multiple rates of
return drive capital to the low-return businesses, thus turning Lex Services PLC into a lowreturn company?
Acceptingalowerratethenthehigherhurdleratewoulddefinitely
bringdowntheoverallreturnofthebusiness.Buttheincreasing
weightofsuchprojectswouldeventuallybringdownthehurdlerate
ofthefirmandthensuchprojectswouldhelptomakeprofitata
lowerrisk.
What could cause change in WACC for Lex Service PLC across time?
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LexServicePLCCostofCapital
Theincreaseinriskoftheprojectundertakencanleadtoanincrease
intheexpectedreturnwhichincreasethecostofequityandthusthe
WACC.Also,increasinglevelsofdebtandequitycanleadtohigher
expectedreturns.ThisistheunderlyingprincipleofMarginalCostof
Capital(MCC).
What is Debt / Capital ratio used by you in estimating WACC for Property Division?
0.565
Lex doesnt 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?
Therateofreturnonanewprojectmightbedifferentfromtheoverall
costofcapitalastheriskstructurefortheprojectmightbedifferent.
Iffirmwidecostofcapitalisusedinthiscase,wemightrejecta
goodproposaloracceptabadproposal.
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?
Thefollowingstepswerefollowed:
1.ThecostofequityiscomputedusingtheCAPMmodel.The
valueofbetausedforthedivisionisleveredfromtheunlevered
betavalueprovidedinthecase.Incaseofthefirm,thevalue
providedinthecaseisdirectlyused.Toleverthebeta,the
midpointvalueoftargetD/Eratioisused.
2.Thecostofdebtisthestandardvalueprovidedinthecase.It
istakentobesameforboththefirmandthedivisions.
3.Thetargetratiosforthefirmareusedfortheestimationof
WACC.
What is Debt / Equity ratio used by you in estimating WACC for Contract Hire Division?
4.89
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LexServicePLCCostofCapital
Lex'scostofcapitalusesthebetaprovidedinthecasefor
calculatingtheconsolidatedfirmWACC.Thisiserroneousasthe
capitalstructureofthefirmisnottakenintoaccountinthismethod.
Thiscanberectifiedusingtheweightedbetaapproachwhereinthe
betaforallthedivisionistakenintoaccountorbyusingtheweighted
WACCapproach.
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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