Star Appliance Company (A) Harvard Case Solution & Analysis

Star Appliance Company (A) Case Solution

In order to compute the cost of capital, different methods could be used by Star Appliance Company including the Dividend Growth Model, Capital Assets Pricing Model, Fama Fench Model or the Enterprise Discount Cash Flow model.

Assumptions does each of these methods depend

The assumptions used in each of the above mentioned methods are given below:

Dividend Growth model:

This model assumes that the dividend is growing at a constant rate in the company. In addition to this, it is further assumed that the rate which is assumed by the company would not be exceeding the required rate of return for the company. Lastly, in this model it is further assumed that the required rate of return for the investors is always known and it is constant.

CAPM:

This method is used to compute the required rate of return for the shareholders, since it can be seen that the company is currently using only the equity portion to finance its capital budgeting decision, therefore, the cost of equity computed with the help of this approach would be the cost of capital for the company. It works by taking into consideration two very important factors that includes the risk as well as the return. The assumptions used in this method is related to the acceptance of the project whose expected return is equals to, or higher than the required rate of return for the company.

Fama French

This model is basically the expansion of capital asset pricing model which includes the size and value factors in addition to the market risk and return factor. This model assumes the fact that value as well as small cap stocks will outperform the markets on a regular basis. In addition to this, the adjustment is required for the small cap and value outperformance of stocks.

Enterprise DCF

Using this method, the free cash flows of the company from the different projects are computed which are discounted back with the help of appropriate discount rate to its present value in order for the evaluation purpose. The model does not use assumptions. However, the method could best be used by considering that all the values used are most accurate.

Which methods are appropriate for Mr. foster to use at Star?

The most appropriate method which should be used by Mr. Foster at Star Appliance Company is the Enterprise Discounted Cash Flow method. Since it takes into account no significant assumptions and compute the free cash flows that are generated from the project, that are discounted back to its present value which should be compared with each other for the further decision.

Analysis of existing hurdle rate of 10 percent.

The hurdle rate of 10% as used by the Star Management is not the appropriate rate in order to evaluate the investment decisions made by the company. The rate of 10% has actually been proposed by the company in its beginning year when the economy was facing depression which should be strongly suggested to re-calculate in order to get the true and fair cost of capital for the future investment decisions with the given economic conditions...............

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