Star Appliance Company A The Case Solution
, capital gain yield and rate of return for reinvestment. Bu computing all these, the Ke is calculated as 12.57%, which is ultimately equal to the cost of capital of the firm because of the fact that the company’s capital structure id equity based.
For the valuation of all three projects DCF method is used by the firm. To compute the free cash flows FCF, cash flows after tax for three alternatives have been used. Depreciation expense have been added to it for calculating operating cash flow. Then the change in working capitals is subtracted and as a result FCF of the firm is determined. After that all these amounts are discounted at their present values by using the discount rate.
By using the DCF approach it is analyzed that the IRR of Dishwasher, Disposer and Trashier are 13.12%, -13.61% and -1.10% respectively. So out of all these projects it could be suggested that firm should add dishwasher in their current product line because comparatively it has positive 13.12% rate of return, a lot better than the other alternative projects. Besides that, it is also more than the calculated discount rate. Also, this project has a positive NPV as compare to other alternative projects, so Star Appliances Company must accept this project.
Note: Refer to all the Exhibits for calculations.
Exhibits
Exhibit 1
| Gordon Growth Model | |
| Dividend Per Share | $ 1.70 |
| Current Stock Price | $ 22.50 |
| Dividend Yield | 7.56% |
| Growth | |
| Dividend Growth Rate | 4.46% |
| Capital Gains Yield | 1.90% |
| EPS Growth Rate | 5.55% |
| Reinvestment Return | 8.14% |
| Average | 5.01% |
| Current Hurdle Rate | 10% |
| Cost of Equity | 12.57% |
| Cost of Capital | 12.57% |
Exhibit 2
| Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 | Year 8 | Year 9 | Year 10 | Year 11 | Year 12 | Year 13 | Year 14 | Year 15 | |
| Project | Dishwasher | |||||||||||||||
| Addition to plant | 7,000.00 | |||||||||||||||
| Production equipment | 21,500.00 | |||||||||||||||
| Installation of equipment | 1,500.00 | |||||||||||||||
| Initial promotion expenditures | 5,000.00 | |||||||||||||||
| Total costs | 35,000.00 | |||||||||||||||
| Net Cash Flow after tax | (35,000.00) | 1,000.00 | 4,000.00 | 8,000.00 | 11,000.00 | 11,000.00 | 11,000.00 | 11,000.00 | 11,000.00 | 11,000.00 | 11,000.00 | 11,000.00 | 11,000.00 | 11,000.00 | 11,000.00 | 11,000.00 |
| Depreciation(Equipment) | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | 1,433.33 | |
| Depreciation(Plant) | 466.67 | 466.67 | 466.67 | 466.67 | 466.67 | 466.67 | 466.67 | 466.67 | 466.67 | 466.67 | 466.67 | 466.67 | 466.67 | 466.67 | 466.67 | |
| Operating Cash Flows | (35,000.00) | 2,900.00 | 5,900.00 | 9,900.00 | 12,900.00 | 12,900.00 | 12,900.00 | 12,900.00 | 12,900.00 | 12,900.00 | 12,900.00 | 12,900.00 | 12,900.00 | 12,900.00 | 12,900.00 | 12,900.00 |
| Working Capital | 69,286.00 | 74,828.88 | 80,441.05 | 86,071.92 | 91,666.59 | 97,166.59 | 102,510.75 | 107,636.29 | 112,479.92 | 116,979.12 | 121,073.39 | 124,705.59 | 127,823.23 | 130,379.69 | 132,335.39 | 133,658.74 |
| Less: Changes in Working Capital | 5,542.88 | 5,612.17 | 5,630.87 | 5,594.67 | 5,500.00 | 5,344.16 | 5,125.54 | 4,843.63 | 4,499.20 | 4,094.27 | 3,632.20 | 3,117.64 | 2,556.46 | 1,955.70 | 1,323.35 | |
| FCF | (35,000.00) | (2,642.88) | 287.83 | 4,269.13 | 7,305.33 | 7,400.00 | 7,555.84 | 7,774.46 | 8,056.37 | 8,400.80 | 8,805.73 | 9,267.80 | 9,782.36 | 10,343.54 | 10,944.30 | 11,576.65 |
| NPV | 1,488.02 | |||||||||||||||
| IRR | 13.12 % |
Exhibit 3:
|
|
Year 0 | Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | Year 6 | Year 7 | Year 8 | Year 9 | Year 10 | Year 11 | Year 12 | Year 13 | Year 14 | Year 15 |
| Project | Food Water Disposal | |||||||||||||||
| Addition to plant | - | |||||||||||||||
| Production equipment | 13,600.00 | |||||||||||||||
| Installation of equipment | 400.00 | |||||||||||||||
| Initial promotion expenditures | 1,000.00 | |||||||||||||||
| Total costs | 15,000.00 | |||||||||||||||
| Net Cash Flow after tax | (15,000.00) | 100.00 | 500.00 | 1,000.00 | 1,650.00 | 3,000.00 | 3,000.00 | 3,000.00 | 3,000.00 | 3,000.00 | 3,000.00 | 3,000.00 | 3,000.00 | 3,000.00 | 3,000.00 | 3,000.00 |
| Depreciation(Equipment) | 906.67 | 906.67 | 906.67 | 906.67 | 906.67 | 906.67 | 906.67 | 906.67 | 906.67 | 906.67 | 906.67 | 906.67 | 906.67 | 906.67 | 906.67 | |
| Depreciation(Plant) | - | - | - | - | - | - | - | - | - | - | - | - | - | - | - | |
| Operating Cash Flows | 1,006.67 | 1,406.67 | 1,906.67 | 2,556.67 | 3,906.67 | 3,906.67 | 3,906.67 | 3,906.67 | 3,906.67 | 3,906.67 | 3,906.67 | 3,906.67 | 3,906.67 | 3,906.67 | 3,906.67 | |
| Working Capital | 69,286.00 | 74,828.88 | 80,441.05 | 86,071.92 | 91,666.59 | 97,166.59 | 102,510.75 | 107,636.29 | 112,479.92 | 116,979.12 | 121,073.39 | 124,705.59 | 127,823.23 | 130,379.69 | 132,335.39 | 133,658.74 |
| Less: Changes in Working Capital | 5,542.88 | 5,612.17 | 5,630.87 | 5,594.67 | 5,500.00 | 5,344.16 | 5,125.54 | 4,843.63 | 4,499.20 | 4,094.27 | 3,632.20 | 3,117.64 | 2,556.46 | 1,955.70 | 1,323.35 | |
| FCF | (15,000.00) | (4,536.21) | (4,205.50) | (3,724.21) | (3,038.01) | (1,593.33) | (1,437.50) | (1,218.87) | (936.97) | (592.53) | (187.60) | 274.47 | 789.03 | 1,350.20 | 1,950.97 | 2,583.31 |
| NPV | (13,232.37) | |||||||||||||||
| IRR | - 13.61 % |
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