Ch_7_Estimating_Cash_Flows_and_Gathering_Information

We want to earn at least our growth rate thus rate

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We want to earn at least our growth rate Thus Rate > Cost of Capital (Weighted Average) Rate = Minimum Attractive Rate of Return (MARR) 42 Example Assume a company has raised the following funds: 10 million shares of common stock. It is currently priced at $30 a share, pays a 1.3% dividend and has grown annually at a rate of 11.5% for the past 3 years. $50 million in short term loans which pay 4.5% per year. $150 million on bonds which pay a coupon rate of 7.5% per year. What is the minimum rate for interest that should be used?
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43 Solution Solution Costs and Amount: Stock: $300 million at 1.3% + 11.5% Loan: $50 million at 4.5% (true cost of loan) Bonds: $150 million at 7.5% (yield to maturity) Total: $500 million Weighted average: This is the minimum interest rate to be used for discounting. 12.8% $300 $500 ⎟ + 4.5% $50 $500 ⎟ + 7.5% $150 $500 ⎟ = 10.38% 44 Study Horizon Study Horizon Estimate the product life cycle Generally examine previous releases (versions) of a product Estimate service life (assets, equipment, etc.) Often available from a vendor Infinite horizon Want to stay in existence indefinitely Good news : when to terminate (end) a project is often a decision that can be made later
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45 Other Information Other Information Risk of a project Uncertainty of cash flows informs one about the uncertainty of the project Distributions of cash flow estimates give the range of possible estimates (very useful) Intangibles Not all information translates to a cash flow Example: Solution approach may appear to raise the “morale” of the workers, etc. May have significant impact on outcome/decision 46 Where to Get Information? Sources in Firm Accounting Records People -- Experience is Invaluable Databases Research and Development (testing) Outside of Firm Reference Books Statistical surveys/abstracts Technical Journals Manufacturer/Vendor Pubs and Trade Shows Vendors
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