Star Appliance

In: Business and Management

Submitted By jakinsanya
Words 1747
Pages 7
Star Appliance Case Study
Star Appliance is looking to expand their product line and is considering three different projects: dishwashers, garbage disposals, and trash compactors. We want to determine which project would be worth doing by determining if they will add value to Star. Thus, the projects that will add the most value to Star Appliance will be worth pursuing. The current hurdle rate of 10% should be re-evaluated by finding the weighted average cost of capital (WACC). Then by forecasting the cash flows of each project and discounting them by the WACC to find the net present value, or by solving for the internal rate of return, we should be able to see which projects Star should undertake.

Conclusion:
After calculating the NPV and the IRR for each project, I have determined that both the dishwasher and the trash compactor projects should be pursued. Both of them have shown positive NPVs at the new discount rate of 11.58% (WACC). Both projects also yielded IRRs greater than the given hurdle rate. The disposal did not meet these requirements and therefore should not be undertaken.

Based on the optimal capital structure analysis, they should pursue as 70% debt proportion, which will give them the lowest cost of capital at 11.58%. Currently Star has no debt in their capital structure, so these new projects should begin to add debt to the company. However, no matter what debt and equity proportions are chosen for each project, the discount rate of 11.58% should be used, as the capital budgeting decisions should be independent of the financing decisions.

Cost of Capital: Current Capital Structure
Gordon Growth Model: (Re = Div Yield + g)
I first solved for the dividend yield by using the equation of next year's dividend divided by this year's stock price. The current year is 1979, so from Exhibit 3 the 1980 dividend is forecasted to be $1.70,…...

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