Q1) Cohen calculated the WACC to be 8.4%, which we don’t agree. The reasons are as follows: Single/Multiple cost of capital: We think a single cost of capital is sufficient because divisions of Nike have similar risk profiles. Weights: We don’t agree with Cohen’s calculation of book value weights. The weights should be calculated with market value of debt and equity because cost of capital shows how much the investors are willing to pay at present, i.e. at market value.
To calculate the cost of debt we could have used the CAPM, but as it is better to be forward looking, it is preferable to take into account the yield to maturity, the probability of default and the dollar loss in the case of default. We can then write the debt cost of capital as: rD = y - pL In this case Nike’s riskiness of debt can be assumed to be equal to zero. Then pL = 0. The debt cost of capital is thus simply the yield to maturity on a Nike’s bond.
Exercise 5-26 The bonds for the industrial development of mass transit would be a better investment for the investor. These bonds would be considered state or local bonds. The interest on these bonds is not taxable on a federal level. Thus, you would have a lower tax liability. The interest on the EE bonds is taxable.
Another argument in favour of hedging is that the company is able to focus on their core business instead of focusing on the market movements of the underlying asset. In our case the interest rate plunged and the future was not favourable. On the contrary, if the interest rate had increased, the upside risk would have been limited. 2. Uncertainty and protection The first mortgage loans generate interest earnings which are not much affected by interest rate fluctuations.
Intrinsic value is considered important in value investing as it allows Buffett to identify stocks or businesses which are undervalued. This is important as “intrinsic value is the value of a company's business, not its stock” (Carbonara, 1999). How is it estimated? Buffett readily admits that intrinsic value is highly subjective (Bruner et al., 2009). Buffett’s method is to estimate ‘discounted cash flows’ (Carbonara, 1999).
We discount a project’s cash flows by its risk- adjusted cost of capital, which is a weighted average (WACC) of the cost of debts, preferred stock, and common equity, adjusted for the project’s risk and debt capacity. Question 2 The $262,500 test marketing cost should not be included in the capital budget analysis because it is a sunk cost. Sunk Costs are defined as an outlay related to the project that was incurred in the past and cannot be recovered in the future regardless of whether or not the project is accepted. Therefore, sunk costs are not incremental costs and are not relevant in a capital budgeting analysis. Question 3 Question 4 If Heavenly Foods does not have an opportunity to lease the space, it is not free or costless to the lite product project.
e. Do you expect that those notes will be called or redeemed? a. MSFT is raising money for general corporate purposes, which may include funding for working capital, capital expenditures, repurchases of stock and acquisitions. Also they choose to raise money at this time because the yields for treasury instruments are low, so Microsoft can issue in a lower rate. b. No, because the yields for treasury instruments are very low at the time, so the premium the company will add to their rate is very low, and the investors will get less money for the same level of riskiness, so the paper is not really cheap.
Since the Walton Work Wear line is in the production stage, its accumulated development costs should be capitalized. The Carroway Cool Top has not started it commercial production which would allow the development costs not to be amortized yet. Also interest costs on loans to generate financing for the R&D activates of a product can be capitalized rather than expensed. The capitalization of interest would allow CCL to reduce taxable income in the future when it is more profitable. I would recommend that CCL make the above changes immediately so that the financail statements are not incorrect.
What is the project’s net present value? When attempting to finance a project, it is important to know the financial health of the company. The net present value aids with analyzing the profitability of a project. It demonstrates the difference between the present value of the cash inflows and the cash outflows (Titman, Keown, & Martin, 2011). When a negative net present value is obtained, it is a sure indicator that the firm should not continue to invest in a project.
It reports basic & diluted EPS before & after tax & capital gain for Y/E Dec 31 and emphasizes its before tax & capital gain EPS figures to shareholders over the after figures as it believes that capital gains are sporadic. However, given that real estate is a key operation of GDL, this emphasis is questionable and might mislead investors from the industry standard of after tax & capital gain EPS. USERS AND USER NEEDS The Audit Committee wants to solve the accounting issues in order to finalize the 2012 financial statements. It wants to ensure accurate and ethical reporting for fair representation of the company’s financial position. Shareholders want to see the company’s financial position and evaluate their investment stance.