Defense Consumer Industrial

Quarter Consolidated
Products Products Products
1 2800000 1725000 1620000 6145000
2 2940000 1776750 1668600 6385350
3 3087000 1830053 1718658 6635711
4 3241350 1884954 1770218 6896522
5 3403418 1941503 1823324 7168245
6 3573588 1999748 1878024 7451360
7 3680796 2059740 1934365 7674901
8 3791220 2121532 1992396 7905148
9 3904957 2185178 2052168 8142303
10 4022105 2250734 2113733 8386572
11 4142768 2318256 2177145 8638169
12 4267051 2387803 2242459 8897313
13 4395063 2459438 2309733 9164234
14 4526915 2533221 2379025 9439161
15 4662722 2609217 2450395 9722334
16 4429586 2687494 2523907 9640987
17 4695361 2768119 2599624 10063104
18 4883176 2851162 2677613 10411951
19 5078503 2936697 2757942 10773142
20 5281643 3024798 2840680 11147121
21 5492909 3115542 2925900 11534351
22 5712625 3209008 3013677 11935310
23 5941130 3305278 3104088 12350496
24 6178775 3404437 3197210 12780422
25 6487714 3506570 3325099 13319383
26 6812100 3611767 3424852 13848719
27 7152705 3720120 3527597 14400422
28 7510340 3831724 3668701 15010765
29 7885857 3946675 3778762 15611294
30 8280150 4065075 3892125 16237350
31 8694157 4187028 4008889 16890074
32 9400000 4300000 4125000 17825000
Sum 166355684 90554621 85521909 342432214
Mean 5198615 2829832 2672560 10701007
Std. dev 1754997 765969 742068 3253095
Coeff.of
variation
= Std. 33.76% 27.07% 27.77% 30.40%
deviation
/Mean

Differenc
e from
the
-3.36% 3.33% 2.63%
consolid
ated
figure
 Relative variablity is measured by coefficient of variation,ie. Std.
Deviation of various quarterly sales figures, as compared to the
mean sales figure. When compared to the Consolidated sales
revenues ,Variation from the mean sales revenues are to be
understood as follows: Sales revenues of Defense varies more than
that of consolidated revenues
followed by sales revenues of Consumer products & lastly Industrial
supplies. So, that which varies/sways more from the central figure
,is said to be risky.
That means, defense is the riskiest .
To find the hurdle rate Julie must have used the CAPM model for calculating the cost of equity along with after-tax
cost of bondswould have found the weighted average costwhich is done as follows:
Cost of Equity as per CAPM
ke=RFR+(Beta*Market risk Premium)
ke=4%+(1.1*10%)
15%
After-tax cost of debt=
11%*(1-40%)=
6.60%
So, WACC= (Wt.e*ke)+(Wt.d*kd)
WACC=(70%*15%)+(30%*6.6%)=
12.48%
along with after-tax
ows:
Pure play” approach to estimating the required return on an investment is to adopt
the beta (for volatility or riskiness)of comparable firms (those whose business
operations are on similar lines) while calculating the WACC] as is given in the
question itself----
"One way was to measure or collect the equity betas of comparable homogeneous
companies and substitute those in place of the firm’s overall beta when calculating
the weighted average cost of capital."
Using Julie’s methodology of adjusting the firm’s hurdle rate based on the relative
variability of each division’s sales in relation to that of the consolidated firm, the
divisional hurdle rates can be calculated as follows:
Defense products:
12.48%+3.36%=15.84%
Consumer Products
12.48%-3.33%=9.15%
Industrial supplies
12.48%-2.63%=9.85%
e relative
rm, the
The above method of evaluating projects for the different divisions ,
using differential hurdle rates, seems to be justified asultimately, it is
the returns from investment that are going to justify the initial
cashout- flows, namely the investment.But instead of study of the
gross sales revenue ,as it is taken here , it can be the net after-tax
earnings ,that follows the investment.This will ensure if the additional
risk is adequately covered.