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Department
Finance
Course Code
MGFB10H3
Professor
Daga

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Description
Mini Case Weighted Average Cost of CapitalAs a junior manager with high energy and a healthy level of enthusiasm Julianne is often required to take part in new project development Her optimism is highly appreciated and being a junior she also gets to do much of the research work required which provides her with excellent learning opportunities Project meetings are often lengthy and fiery debates among senior managers are not uncommon Most recently a team of Juliannes coworkers advocated developing and selling a new software application that they estimated may increase significantly the firms income over the next five yearsHowever a senior manager was not convinced by the proposal and formed a team to argue that the projects net present value is negative and thus should be rejected An entire day was spent in meetings the debate in accepting or rejecting the proposal coming down to which discount rate should be used Indeed despite similar statements that the market risk of the project is equivalent to the market risk of the firms other projects the pro and con teams were coming up with very different discount rates Therefore Julianne decided to dust up her old finance book and redo the discount rate calculations from scratchFirst all the projects that the firm undertakes are financed so that the debt to equity ratio is similar to the firms ratio This ratio has been constant for the past couple of years at 25 and the CEO stated that this ratio will also be utilized in the future The main effect of leverage on valuation follows from the interest tax deduction and the level of debt is not significantly high to threaten financial distress Shuffling through the previous calculations of the discount rate Julianne finds out the followingFirst the teams have used different assessments of the riskfree rate For instance the pro team has used as the riskfree rate the 5year yield on the Government of Canada strip bonds at 168
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