Lehman Brothers Case Study
Supply chain issues and the strong dollar negatively affected revenue too. Plans are In place to address top line growth and operating performance. To boost revenue, the company would develop more athletic shoes in the mid priced segment which has been overlooked by Nikkei in recent years. They also planned to push their apparel line which under strong leadership had performed very well to control expenses.
Revenue growth targets are around 8-10% and earnings targets are above 15%. Analyst reactions were mixed as some of them thought this was too aggressive.
Lehman Brothers recommended a strong buy while others expressed misgivings and recommended a hold. At this point, North Point Group decided to do their own analysis in order to decide if Nikkei shares should be purchased for the fund. The weighted average cost of capital (WAC) Is the rate that a company Is expected to pay Its debt and equity holders to finance Its assets.
It Is the minimum return that a company must earn on existing asset base to satisfy Its owners, creditors, and other providers of capital or they will invest somewhere else.
Companies raise money from many sources such as common and preferred equity, straight, convertible, and exchangeable debt, options, warrants, pension liabilities, executive stock options, governmental subsidies, and others. Different securities, which represent different sources of finance, are expected to generate different returns. WAC Is calculated taking Into account the relative weights of each component of the capital structure- equity and debt, and Is used to see If the investment is worthwhile to take part in. Management notices the cost of capital while making a financial decision.
The concept is very relevant In the following managerial decisions and hence its importance: (1) Capital Budgeting Decision.
Cost of capital may be used as the tool for adopting an investment proposal. Naturally, the firm will choose the project which gives a satisfactory return on investment which would never be less than the cost of capital incurred for its financing. In the many methods of capital budgeting, the cost of capital Is the main factor in deciding the project out of different proposals pending before the management. It determines the acceptability of all Investment opportunities Day measuring Atlanta performance. 2) Designing ten corporate Financial Structure. The cost of capital is a significant factor in designing the firm’s capital structure.
The cost of capital is influenced by changes in capital structure. Financial executives keep an eye on capital market fluctuations and try to achieve the economical and sound capital structure for the firm. They may try to substitute the various methods of finance in an attempt to minimize the cost of capital and to increase the market price and the earning per share. (3) Deciding about the Method of Financing.
Financial executives must have knowledge of fluctuations in the capital market and should analyze the rate of interest on loans and normal dividend rates in the market from time to time.
Whenever company requires additional finance there are better choices of the source of finance which bears the minimum cost of capital. Although cost of capital is an important factor in such decisions, but equally important are the considerations of relating control and of avoiding risk. (4) Performance of Top Management. The cost of capital can be used to evaluate top executive financial performance.
Evaluation of the financial performance will involve a comparison of actual profitability of the projects and along with the projected overall cost of capital and an appraisal of the actual cost incurred in raising the required funds. (5) Other Areas.
The concept of cost of capital is also important in others areas of decision making, such as dividend decisions, working capital policy, and more. [pick] One important question is if Joanna Cohen should use a single or multiple of capital for each of Nine’s footwear and apparel divisions? We agree with the use of single cost rather than multiple costs of capital.
The reason of estimating WAC is to value the cash flows of the entire company that is provided by Kim Ford. Plus, Nikkei equines segments have a similar risk and thus a single cost is sufficient for this analysis.
Joanna Cone’s cost of debt was incorrect. An important fact is the WAC is used for discounting future cash flows, thus all components of the cost must reflect the firm’s concurrent or future abilities in raising capital. Cohen wrongly used the historical data in estimating the cost of debt. She divided interest expense by the average balance of debt to get 4. 3% of before tax cost of debt.