Wyatt Oil is a multidivisional company with activities spanning the following three industries: oil exploration, oil refining, and gas & convenience store. The following table provides some information on Wyatt's division asset risk and profitability:
|
Division
|
Asset /3
|
Expected FCF
|
Expected growth rate (g)
|
|
Oil exploration
|
1.4
|
450
|
4%
|
|
Oil refining
|
1.1
|
525
|
2.5%
|
|
Gas & convenience store
|
0.8
|
600
|
3%
|
Suppose that the yield on government with a maturity that is consistent with that of Wyatt's projects is 3%, and that the market risk premium is 5%.
Compute the cost of capital for each one of Wyatt's divisions.
Treat the FCF indicated in the table above as a perpetuity and value each one of Wyatt's divisions.
Use your calculations to determine the overall asset /3 and cost of capital for Wyatt's oil.
Suppose that the Gas & convenience store division decides to fund a new project, and uses the cost of capital of Wyatt's oil to compute the project's NPV, what kind of problem can this entail?
Suppose that Wyatt decides to open a shipping division. The following information is available on comparable companies in that industry:
Company /3E Estimated DN
XY Z 1.4 0.2
ABC 1 0.3
KJL 1.1 0.1
Assume that PD = 0 for both Wyatt's and the comparables.
1. If Wyatt's chooses DN = 0.4 for the shipping division, what are the /3 and corresponding cost of capital for Wyatt's expansion plan? (Note: when answering this question clearly state the assumption you make on the companies' debt policy)
2. Suppose that Wyatt's ignores the information in the table, and proceeds evaluating the expansion into shipping using the corporate cost of capital. What can of problem can this create? Does your answer differ from the one you gave in point (d)? Explain.