Castroverde Guancia Octavio BSA 2A Case Study 3

CAN ONE SIZE FIT
ALL?
m
er as
Case Study Analysis
co
eH w
o.
rs e
ou urc
o
aC s
vi y re
ed d
Submitted by:
ar stu
John Paul L. Castroverde

Jorgette Marie D. Guancia
is
Jovelyn C. Octavio
Th
BSA – 2A
sh
This study source was downloaded by 100000819030759 from CourseHero.com on 11-24-2021 07:47:50 GMT -06:00
https://www.coursehero.com/file/109137169/Castroverde-Guancia-Octavio-BSA-2A-Case-Study-3docx/
I. Brief Summary
Oceanic Corporation is a privately owned corporation whose main business was to

provide ship repair services. It was established in 1994 by Glen Rodgers III. Along with the
corporation’s initial success, by the year 1998, the company went to a successful public
offering. The corporation's stock price had risen from its initial value of $10 to its current
level of $35 per share with currently 5 million shares outstanding. In 1999, the company
issued 30-year bonds at par, with a face value of $1000 and a coupon rate of 10% per year,
and managed to raise $40 million for expansion. Currently, the AA-rated bonds had 25 years
left until maturity and were being quoted at 91.5% of par. In the course of time, The Oceanic
Corporation utilized a new method for fabricating composite materials that the firm's
m
engineers had developed. They then established the Advanced Materials Group (AM Group),
er as
which was dedicated to pursuing this technology. The firm recruited Larry Stone, a senior
co
eH w
engineer with an MBA degree to head the AM Group. Larry figured out that most of the
o.
corporation’s projects were decided out of luck and he realize that this must be changed for it
rs e
ou urc
is essential to calculate the firm's hurdle rate and use it in future. Stephanie, Larry's assistant
agreed for a change, she then volunteered to do some number crunching for Larry who
o
believes that when it comes to the hurdle rate for new projects, one size hardly ever fits all!
aC s
vi y re
II. Point of View

ed d
The perspective of this case focuses on Stephanie who volunteered to reckon the
ar stu
corporations hurdle rate for the firm's new project.

is
Th
III. Statement of the Problem
Larry Stone, a senior engineer that was recruited to lead the Oceanic Corporation's new
sh
project was determined to know the corporation's hurdle rate for the sake of the firm's new
project and in order to change and break the firm's attitude of deciding out of instinct when it
comes to approving projects.
Secondary Problems
a. The realistic expectation to the assumption of Stephanie if it can be applied

practically in the company.
b. The probability that the hurdle rate calculated by Stephanie would remain
constant.
IV. Areas for Consideration

a. Hurdle Rate
b. Flotation Costs
c. Weight and Cost of Debt
m
d. Weight and Cost of Equity
er as
co
eH w
V. Alternative Courses of Action (ACAs)
o.
rs e
a. Calculate the hurdle rate using the book value with flotation costs.
ou urc
b. Calculate the hurdle rate using the book value without the flotation costs.
c. Calculate the hurdle rate using the market value without the flotation costs.
o
aC s
vi y re
VI. Quantitative and Qualitative Analysis of ACAs

a. Calculate the hurdle rate using the book value with flotation costs.
Estimated YTM = [interest + (FV – MV)/n] / (FV+MV)/2
ed d
= [100 + (1,000 – 915) / 25] / (1,000 + 915) / 2.

ar stu
= 103.4 / 957.5
= 10.80%
is
Th
After tax cost of debt = 10.80% x (1 – 0.34)

= 7.13%
sh
Cost of Equity
CAPM Approach
b = 1.5 rm = 10% risk free rate = 4%
Rs = rRF + (rM – rRF) b

= 4% + (10% - 4%) 1.5
= 13%
Discounted Cash Flow (DCF) Approach
m
er as
Year Dividen Growth Rate Rs = (D1 / Po) + g
co
eH w
d = [0.25 x (1 + 0.1662) / 35] + 0.1662)
o.
1998 0.10 - = 0.1745 or 17.45%
rs e
ou urc
1999 0.12 0.20
2000 0.15 0.25
o
2001 0.18 0.20 Bond Yield-Plus-Risk-Premium Approach

aC s
2002 0.20 0.111

vi y re
Rs = Rd + RP
2003 0.22 0.10 = 10% + 6% (Solved above)
2004 0.25 0.136 = 16%
ed d
ar stu
Total 0.997
Average 0.1662 or 16.62%
is
CAPM 13%
Th
DCF 17.45%
Bond Yield-Plus-Risk-Premium 16%
sh
Average Cost of Equity 15.48

%
b. Calculate the hurdle rate using the book value without the flotation costs.
Weight
Debt $ 40,000 40%
Equity 60,000 60%
Total $100,000 100%
Hurdle Rate = (Weight of debt x Cost of debt) + (Weight of Equity x Cost of Equity)
= (0.40 x 0.0713) + (0.60 x 0.1548)
= 0.029 + 0.093
= 0.122 or 12.20%
Strengths
m
er as
- Without flotation costs the company can avoid overstating its cost of capital.
co
eH w
- The company can avoid ongoing costs and expenses like higher professional fees.
o.
- The upper management of the business will not be distracted from running the company
rs e
during flotation process.
ou urc
Weaknesses
o
- It will be hard to realize the investments of the venture capitalists and other investors.
aC s
vi y re
- There might be a possibility that the company missed an opportunity to access new
capital to the business and placing value on the firm.
ed d
ar stu
c. Calculate the hurdle rate using the market value without the flotation costs.
is
Strengths
Th
Weaknesses
sh
VII. Conclusion, Recommendation and Action Plan
m
er as
co
eH w
o.
rs e
ou urc
o
aC s
vi y re
ed d
ar stu
is
Th
sh
Powered by TCPDF (www.tcpdf.org)

Castroverde Guancia Octavio BSA 2A Case Study 3

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Castroverde Guancia Octavio BSA 2A Case Study 3

Uploaded by

Copyright:

Available Formats

CAN ONE SIZE FIT

John Paul L. Castroverde

Oceanic Corporation is a privately owned corporation whose main business was to

II. Point of View

corporations hurdle rate for the firm's new project.

III. Statement of the Problem

a. The realistic expectation to the assumption of Stephanie if it can be applied

IV. Areas for Consideration

VI. Quantitative and Qualitative Analysis of ACAs

= [100 + (1,000 – 915) / 25] / (1,000 + 915) / 2.

After tax cost of debt = 10.80% x (1 – 0.34)

Rs = rRF + (rM – rRF) b

Discounted Cash Flow (DCF) Approach

2001 0.18 0.20 Bond Yield-Plus-Risk-Premium Approach

2002 0.20 0.111

Average Cost of Equity 15.48

VII. Conclusion, Recommendation and Action Plan

You might also like