Second, PPC has been using a single company-wide rate for their multi-divisional company. In either instance the company is not maximizing wealth. Statement of Facts and Assumptions: PPC has been calculating their after tax cost of debt using the coupon rate of 12% instead of the actual interest rate which is 8%. Taking the 8% interest rate into account, PPC’s actual cost of capital would be calculated as: [. 08(1-. 34)]= 5. 28%. PPC has simply been using 10% (their equity growth rate) as their cost, but must instead either use the CAPM model to calculate their cost of equity, or the Dividend-growth model.
If they use the CAPM model, which is the most accurate, their cost of equity will be: . 078+. 8(. 1625-. 078)=14. 56%. Or they can use the Dividend-growth model and their cost of equity would be: (2. 7/63)+. 1=14. 29%. Both are acceptable but, because the Dividend-growth model is subjective, and the coupon rate (that PPC was originally using is a sunk cost, they should use the market rate).
Thus using the market rate to calculate CAPM you use the Beta and market risk premium which are both based on the market rate and more accurate.
The Essay on Bystander Effects Linked To The Cost Benefit Model
Latene and Darley (1970) formulated a five-stage model to explain why bystanders at emergencies sometimes do and sometimes do not offer help. An alternative cognitive theory is the Cost-Benefit Model developed by Piliavin (1981) to explain the results of helping behaviour studies. This theory suggests that whether we help or not depends on the outcome of weighing up both the costs and benefits of ...
Finally, their company WACC of 9% that they have calculated is incorrect and given the above calculations, their WACC using CAPM would be: [5. 28(. 5)+14. 6(. 5)]=9. 94% and their WACC using Dividend-growth would be: [5. 28(. 5)+14. 3(. 5)]=9. 79%. Either way, it is significantly larger than the 9% they had calculated. It should also be stated that PPC would benefit by using the target rate because they are planning longer term into their future. Analysis: Using a single cut-off rate for the entire company has increased the overall risk of their company.
The use of an acceptable range based on a company-wide average cost of capital inappropriately leads the company to invest in divisions with high risk that should possibly have a higher required rate of return or to not invest in low risk divisions that would be profitable, merely because they do not exceed the company rate. Thus, using a WACC for each division will more accurately allow the corporation to decide which projects to accept and deny based on the specific risk factors of the section instead of the risk of the entire company which has been skewed because of diversification.
Based on my calculations, the company wide WACC and cut off rate that should be used is 9. 94% based on CAPM or 9. 8% based on Dividend-growth, and any projects that are below that percentage should not be accepted for the company as a whole. Recommendations: Overall, I would recommend that PPC recalculate their WACC per each specific division and establish multiple cutoff rates instead of calculating a company wide WACC cutoff rate.
This will benefit them the most in accepting and denying projects that will meet the appropriate cutoff rate that each division is susceptible to based off the specific risk each division must overcome. When recalculating their WACC, it would benefit them most to use the CAPM model to determine their cost of equity, but using the Dividend-growth model is also acceptable. To determine the cost of debt, they must remember to use the actual interest rate instead of the coupon rate to determine the after tax cost accurately.
The Essay on Auditing – The Risk-Based Approach Introduction
Risk, plays a large part in the world of Auditing. Audit risk, represents risk to an auditor or an audit firm, as the risk of paying damages to a client may arise out of negligent work when trying to show a true and fair view of a set of company accounts. All audit work involves some level of risk; this may be because a set of company accounts have been misstated due to error or fraud, or the ...
