1/15/2015

LexServicePLCCostofCapital

Lex Service PLC Cost of Capital

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WACC
What is Debt / Equity ratio used by you in estimating WACC for Property Division?
1.30

What are the issues involved in using multiple WACC?

IfmultipleWACCratesareused,multipleobservationsarerequired
forthecalculationofbetaandriskpremiums.Itisnotalways
possibletoestimatedivisionbetaofafirmasitisnottradedonthe
openmarketsandthusthecostofequityisdifficulttodetermine.

Why contract hire is shown with higher level of leverage?

ThecontracthireisinjointventurewithLombardNorthCentralPLC
whichisapartoftheNationalWestminsterBank.WhileLexis
responsibleforthedailyoperations,Lombardprovidesthefundingfor
thefleetwhichisprovidedbythebankintheformofdebt.Thus,
thereisahigherlevelofleverage.

How you estimated Lex Services Cost PLC consolidated corporate cost of capital and how
such estimates should be used? *
Theconsolidatedcorporatecostofcapitalwasestimatedusingthe
targetD/Eratiosforindividualdivisions.TheweightedWACCforthe
divisionsisusedforcalculatingthefirmWACC.
Anotherapproachthatcanbeusedistofindthebetaforthefirm
usingtheweightedbetasofthedivisions.Thisvalueisusedtofind
thecostofequityandthentheWACC.

What is Debt / Capital ratio used by you in estimating WACC for Contract Hire Division?
77.4

If you can justify a different risk-adjusted discount rate for each division, then why not for
each business unit within a division, or each project within a unit, or each separately
identifiable stream of cash within a project?
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LexServicePLCCostofCapital

Thisistheoreticallypossiblebutimplementingitpracticallyisnot
feasibleaseverystreamwillhaveadifferentbetaanddifferentrisk
premium.Estimatingbetaforindividualstreamisnotpossibleas
theyarenotpubliclytradedordonothaveabenchmarkagainst
whichtheycanbecompared.

Whether Lex Services PLC should employ a single cost of capital as a hurdle rate for all
projects throught the company, or multiple cost of capital estimates, one for each major
division?
Iftheriskprofileofthedivisionissimilartotheoverallfirmthenthe
samehurdleratecanbeused.Butiftheriskprofileofaproject
(especiallyanewone)isdifferentfromthefirm,thenmultiplehurdle
rateshavetobeused.

What type of weights you used in estimating WACC?

Book Value

Market Value

Target Value

Lex Services PLC

Contract Hire
Automotive
Distribution Division
Property

What is Debt / Capital ratio used by you in estimating WACC for Lex Services PLC?
0.1525

Why would the company ever accept a project with, say, a 10.5% rate of return that meets
that divisions lower hurdle rate while turning down a project with a higher expected return
(e.g. 12%) that might be just below its divisions higher hurdle rate? Wont multiple rates of
return drive capital to the low-return businesses, thus turning Lex Services PLC into a lowreturn company?
Acceptingalowerratethenthehigherhurdleratewoulddefinitely
bringdowntheoverallreturnofthebusiness.Buttheincreasing
weightofsuchprojectswouldeventuallybringdownthehurdlerate
ofthefirmandthensuchprojectswouldhelptomakeprofitata
lowerrisk.

What could cause change in WACC for Lex Service PLC across time?
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LexServicePLCCostofCapital

Theincreaseinriskoftheprojectundertakencanleadtoanincrease
intheexpectedreturnwhichincreasethecostofequityandthusthe
WACC.Also,increasinglevelsofdebtandequitycanleadtohigher
expectedreturns.ThisistheunderlyingprincipleofMarginalCostof
Capital(MCC).

What is Debt / Capital ratio used by you in estimating WACC for Property Division?
0.565

What is your assumed beta for Debt in estimation of WACC?

0

Lex doesnt fund itself at the divisional level (except for contract hire), and its equity
investors posses a claim on the whole company. So why accept any rate of return other
than the overall corporate-wide cost of capital?
Therateofreturnonanewprojectmightbedifferentfromtheoverall
costofcapitalastheriskstructurefortheprojectmightbedifferent.
Iffirmwidecostofcapitalisusedinthiscase,wemightrejecta
goodproposaloracceptabadproposal.

What is Debt / Capital ratio used by you in estimating WACC for Automotive Distribution
Division?
0.1304

Describe the process followed by you in estimating WACC for the firm and the division?
Thefollowingstepswerefollowed:
1.ThecostofequityiscomputedusingtheCAPMmodel.The
valueofbetausedforthedivisionisleveredfromtheunlevered
betavalueprovidedinthecase.Incaseofthefirm,thevalue
providedinthecaseisdirectlyused.Toleverthebeta,the
midpointvalueoftargetD/Eratioisused.
2.Thecostofdebtisthestandardvalueprovidedinthecase.It
istakentobesameforboththefirmandthedivisions.
3.Thetargetratiosforthefirmareusedfortheestimationof
WACC.

What is Debt / Equity ratio used by you in estimating WACC for Contract Hire Division?
4.89

Is there a Bias in the Estimate of Lexs Cost of Capital?

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LexServicePLCCostofCapital

Lex'scostofcapitalusesthebetaprovidedinthecasefor
calculatingtheconsolidatedfirmWACC.Thisiserroneousasthe
capitalstructureofthefirmisnottakenintoaccountinthismethod.
Thiscanberectifiedusingtheweightedbetaapproachwhereinthe
betaforallthedivisionistakenintoaccountorbyusingtheweighted
WACCapproach.

What is Debt / Equity ratio used by you in estimating WACC for Lex Services PLC?
0.18

What is Debt / Equity ratio used by you in estimating WACC for Automoive Distribtuion
Division?
0.15

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