You have recently been hired by Hubbard Computer, Inc. (HCI) in its relatively new treasury management department. HCI was founded eight years ago by Bob Hubbard and currently operates 74 stores in the Southeast. HCI is privately owned by Bob and his family, and had sales of $97 million last year.
HCI primarily sells to in-store customers who come to the store and talk with a sales rep. The sales rep assists the customer in determining the type of computer and peripherals that are necessary for the individual customer's computing needs. After the order is taken, the customer pays for the order immediately and the computer averages 15 days, and it is guaranteed in 30 days.
HCI's growth to date has been financed by its profits. When the company had sufficient capital it would open a new store. Other than scouting locations, relatively little formal analysis has been used in its capital budgeting process. Bob has just read about capital budgeting techniques and has come to you for help. For starters the company has never attempted to determine its cost of capital, and Bob would like you to perform the analysis. Since the company is privately owned it is difficult to determine the cost of equity for the company. Bob wants you to use the pure play approach to estimating the cost of capital for HCI and has chosen Dell as a representative company.
Question
You used Dell as a pure play company to estimate the cost of capital for HCI. Are there potential problems with this approach in this situation?