Star Appliances - Methods He Can Use to Find Cost of Capital

Methods He Can Use to Find Cost of Capital:

1. Dividend Growth model:

1. the dividend growth rate is constant;
2. the growth rate cannot equal or exceed the required rate of return;
3. the investor's required rate of return is both known and constant.

1. CAPM:

1. Calculates an investor’s compensation in two ways: time value of money (return) and risk
2. Assumes: If the expected return does not meet or beat the required return, then the investment should not be undertaken.

1. Fama French

1. Assumes the fact that value and small cap stocks outperform markets on a regular basis
2. Adjusts downward for small cap and value outperformance.

1. Enterprise DCF

1. Defined: value of all cash flow generating assets is the PV of the expected cash flow stream given some appropriate discount rate
2. Cannot find assumptions
3. This method can be tricky because the model is only as good as the values that are put in to it- assume these are the best/most accurate numbers you can get

1. Free Cash Flow to Equity

1. Defined: A measure of how much cash can be paid to the equity shareholders of the company after all expenses, reinvestment and debt repayment.

FCFE = Net Income - Net Capital Expenditure - Change in Net Working Capital + New Debt - Debt Repayment

1. Assumes stability. (Difference between capital expenditures and depreciation will narrow; Beta closer to one)

Which project?

The NPV rule states one should accept the project if the NPV is positive. According to the IRR rule, one should accept the project if the IRR is greater than the company’s minimum rate of return.

Min ROR: 16%, so only the dishwasher

The current hurdle rate of 10% should be re-evaluated by finding the weighted average cost of capital (WACC). Then by forecasting the cash flows of each project and discounting them by the WACC to find the net present value, or by solving for the internal rate of return, we should be able to see which projects Star should undertake.