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Langtry Falls Expansion Plan Case Solution

Solution Id Length Case Author Case Publisher
2089 970 Words (5 Pages) Marc Lipson Darden School of Business : UV7508
This solution includes: A Word File A Word File and An Excel File An Excel File

Both of the financial professionals are presenting a biased opinion  by not considering all the factors at hand. Mr. Connors is comparing the investment only with the risk free government treasury bond whereby interest rates offered by government are at record low level in order to provide a stimulus to a recovering economy. On the other hand, Ms. Windsor compared the potential return with solely equity market thereby evaluating the prospects against average return provided by S&P 500. However, the potential growth opportunities are best evaluated while accounting for the target capital structure of the firm to finance those growth opportunities for which WACC suits the most. 

Following questions are answered in this case study solution

  1. How should we reconcile the huge variation between Connors (talking about the low rates on debt) and Windsor (talking about the higher hurdle rates of various equity alternatives)? Does the WACC (opportunity cost of capital) even matter if there is such wide range in various philosophies from apparently intelligent financial professionals??

  2. The WACC is the “weighted average” of what it costs to raise capital. Essentially, the opportunity cost of capital. It is not technically the same thing as the hurdle rate for investment decision, but it is often used to make those decisions. It is also the discount-rate by which future cash flows should be valued. It is not the IRR, since that “Internal rate of return” is just the discount rate that sets the NPV of cash flows equal to zero (as compared to the required investment). Having said all of this, what do you think is the WACC for the potential expansion project of Langtry Falls???

  3. Realistically, and given the nature of the data inputs, should they be looking at a single “rate” for cost of capital during the next ten years, or different cost of capitals for different intervals of the next ten years?

  4. There are various sources of data and methodologies for calculating Beta (sensitivity to “the market”). The effective tax rate could change if they start losing money, if tax laws change, or if rates increase. Consider or ignore these issues?

  5. Regardless of how she analyzes the data and calculates her “cost of capital”, what is the single biggest “caveat” that Garner should tell her Board about her line of thought (conclusion)? In other words, regardless of what she estimates, what is the biggest risk in the determination of whether she is adding Economic Value by expanding her firm with this cost of capital against the cash flows she hopes to generate?

  6. Should the risk factors employed in determining the cost of capital be those of the entire firm or from the more narrow (projected) financial, marketing and risk characteristics of the new project? In other words, is the cost of capital used in the decision to expand that of the entire firm including the new project or just for the new project?

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Case Analysis for Langtry Falls Expansion Plan

2. The WACC is the “weighted average” of what it costs to raise capital. Essentially, the opportunity cost of capital. It is not technically the same thing as the hurdle rate for investment decision, but it is often used to make those decisions. It is also the discount-rate by which future cash flows should be valued. It is not the IRR, since that “Internal rate of return” is just the discount rate that sets the NPV of cash flows equal to zero (as compared to the required investment). Having said all of this, what do you think is the WACC for the potential expansion project of Langtry Falls???

WACC Calculation

 

 

Estee Lauder

Ralph Lauren

Pvh Corp

Coach Inc

Tiffany & Co

Fossil Group

Cost of Equity

 

 

 

 

 

 

 

Beta from Bloomberg

 

0.92

1.02

1.12

1.07

1.08

1.28

Average Market Beta

1.08

 

 

 

 

 

 

Risk Free Rate

2.15%

 

 

 

 

 

 

Market Risk Premium

6%

 

 

 

 

 

 

Re

6.31%

 

 

 

 

 

 

Cost of Debt

 

 

 

 

 

 

 

Yield to Maturity on Long Term Debt

 

3.37%

3.18%

4.56%

4.39%

4.07%

4.97%

Average Yield

4.09%

 

 

 

 

 

 

Rd

4.09%

 

 

 

 

 

 

Weights of Debt & Equity

 

 

 

 

 

 

 

Long Term Debt

 

1910

839

3197

862

878

610

Short Term Debt

 

331

23

19

15

229

26

Total Debt

 

2241

862

3216

877

1107

636

Shares Outstanding

 

368

81

79

279

125

48

Stock Price

 

97.28

71.52

104.88

46.32

91.54

9.1

Total Equity

 

             35,799

         5,793

         8,286

            12,923

            11,443

                        437

Total Capital

 

             38,040

         6,655

      11,502

            13,800

            12,550

                    1,073

Weight of Debt

 

5.89%

12.95%

27.96%

6.35%

8.82%

59.28%

Weight of Equity

 

94.11%

87.05%

72.04%

93.65%

91.18%

40.72%

Average Debt Weight

20.21%

 

 

 

 

 

 

Average Equity Weight

79.79%

 

 

 

 

 

 

Tax Rate

35%

 

 

 

 

 

 

Weighted Average cost of Capital

5.58%

 

 

 

 

 

 

3. Realistically, and given the nature of the data inputs, should they be looking at a single “rate” for cost of capital during the next ten years, or different cost of capitals for different intervals of the next ten years?

The company should not look at a single cost of capital to evaluate projects for the next 10 years. The company should adjust the cost of capital according to target capital structure. Also the rate of return on equity and debt do not tend to remain constant whereby timely adjustments in required return on both equity and debt to be made for while calculating revised cost of capital. 

4. There are various sources of data and methodologies for calculating Beta (sensitivity to “the market”). The effective tax rate could change if they start losing money, if tax laws change, or if rates increase. Consider or ignore these issues?

The tax rate is particularly important for a company for various reason.

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