Case Study: GLOBAL COST OF CAPITAL:
Question 1: For component Costs:
A. Compute the before- and after-tax costs of ITS debt.
B. Compute the cost of equity (assuming all funds come from internal sources):
i. Using the constant growth Gordon Dividend Valuation Model
ii. Using the Security Market Line Equation (SML) from the Capital Asset Pricing Model (CAPM).
Question 2: Compute the Weighted Average Cost of Capital (WACC) based on cost of equity estimated under the Gordon Dividend Valuation Model.
A. Using book value weights for debt and equity
B. Using market value weights for debt and equity.
Question 3: Compute the WACC based on cost of equity estimated under the CAPM.
A. Using book value weights for debt and equity
B. Using market value weights for debt and equity
Question 4: Address the pros and cons of using market value weights versus book value weights and reconcile the divergent views of Crown and Chang.
Question 5: Compute the Required Rate of Return for the project(s), adding appropriate risk premiums subjectively. These risk premiums can differ depending on the nature and continental location of the projects.
Question 6: Make a recommendation as to which, if any, of the investments identified in Table should be accepted taking into account the capital constraint.
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Table. ITS's N+6 New Projects Under Consideration (ROR Based on Book-Value weights)
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Project
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Net Investment Cost (US$, in millions)
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Proposed Location
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Estimated IRR
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Type of Project
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International Risk Premium
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Required Rate of Return (RRR)
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DECISION (ACCEPT or REJECT)
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1
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$500
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Europe
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26.30%
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Existing product, new market
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2
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$400
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USA
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13.50%
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New product, new market
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3
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$650
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Asia
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8.60%
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Expand existing product in existing market
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4
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$1,500
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Asia
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23.40%
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New product, existing market
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5
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$350
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USA
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24.60%
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Replace Equipment
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6
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$750
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Europe
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10.20%
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Expand existing product in existing market
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7
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$250
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Asia
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26.70%
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Existing product, new market
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8
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$325
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Asia
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18.80%
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New product, existing market
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