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Lawn Depot, Inc.


          LAWN DEPOT, INC.
    Establishing the Optimal
        Capital Budget
                      Paige Baccus
                         Arif Hussain
                          Ari Kempler
             Rupetrus Musamuli
Lawn Depot, Inc.


                         OVERVIEW
         Background
         WACC / MCC
      IRR / IOS
      MIRR
      SML / CAPM
      Risk Adjustment

Lawn Depot, Inc.


            BACKGROUND /
              HISTORY
     National Retail Outlet
      Specializing in Garden
      Supplies and
      Equipment
     Family Owned and
      taken Public in 1983
     Future of Company
      relies on proper
     analysis of capital
     investment decisions
Lawn Depot, Inc.


               Cost of Capital
                Components
All figures are based on market values
ITEM         VALUE WEIGHT
Short-term debt $ 50,000,000     5%
Mortgage bonds 283,465,550       30%
Preferred Stock 145,000,000      15%
Common Equity 480,000,000        50%
TOTAL $958,465,550 100%

Lawn Depot, Inc.
Weighted Average Cost of
        Capital
WACCRE
 Kd*Wd (1-t) + Kps*Wps + Kre*Wre +
Ksd*Wsd (1-t)


  =.3*.08(.6) + .15*.09 + .5*.166 +
.05*.07(.6) = 11.3%
WACCCS
  =.3*.125(.6) + .15*.09 + .5*.191 +
.05*.07(.6) = 13.6%

Lawn Depot, Inc.


BREAK P0INT ANALYSIS
     Exhaustation of internal funds forces
      the firm to seek external capital.
       Flotation costs and effects of
        market
        pressures.
       Cost of retained earnings is less than
        the cost of issuing new equity.
       Break point analysis= Re x b/ Equity
        Fraction
        = .4(80,000)/ 0.5
        =64,000 + non-cash exp.
        =64,000,000 +
60,000,000(depr)
        =$124,000,000

Lawn Depot, Inc.


              MCC Schedule
13.5%
11.4%
0
$124
Dollars in millions

Lawn Depot, Inc.


     ESTIMATED IRR’s &
    NPV’s FOR PROJECTS
Project Initial Cost Cash Inflows
Life IRR NPV
  A            $ 30.0     $ 6.26
12yrs        18% 9.8
     A*            30.0     7.81
8          20      9.62
     B           160.0    27.36
15            15    N/A




Lawn Depot, Inc.
                   IOS Schedule
20%
18%
15%
30
60
90
120
150
180
210
240

Dollars in millions

Lawn Depot, Inc.


                   MCC VS IOS
     MCC determined by
      WACC
     WACC found under
      relative certainty
     Therefore, MCC
      schedule has high
      degree of certainty

     IOS assumes cash flows under
      uncertainty
     IOS schedule will be less certain
      then MCC schedule

Lawn Depot, Inc.


       MCC Schedule and
         IOS Schedule
20%
17%
14%
11%
  50               100   150 200   250
Dollars in millions
IOS
MCC

Lawn Depot, Inc.


          ACCEPT/REJECT
            DECISIONS
     All projects IRR are higher than
      WACC so accept all
     A and A* are mutually exculsive
     The IRR’s of both projects exceed
      the cost of capital
     NPVAA is greater than the NPVAA*
     Conflicts between IRR and NPV of
      the projects
     Accept A, because NPV is higher
     Accept B, because IRR is above
      WACC

Lawn Depot, Inc.


        TAKING RISK INTO
           ACCOUNT
     Riskiness of projects absent from
      analysis
     In real world, must account for risk
     Two main methods to account for
      risk:
 1. Adjust firms cost of capital up or
down to account for differential risk
  2. Lower IRR’s of riskier projects and
raise IRR’s of less risky projects

Lawn Depot, Inc.
           MIRR ANALYSIS
     IOS developed using IRR
     IRR assumes cash flows reinvested
      at IRR rate
     Using MIRR to determine IOS
      schedule will cause downward shift
      of IOS schedule
     Reason for downward shift is lower
      discount rate, or WACC, inherent in
      MIRR

Lawn Depot, Inc.


              MIRR EFFECT
     Example, Project A* : IRR = 20% vs.
      MIRR = 14.55%
     Project B has an IRR of 15%
     Project B is barely above the MCC
      schedule or WACC of 13.6%
     Under MIRR analysis, Project B
      would probably not be accepted
     Conclusion, projects accepted under
      IRR not necessarily accepted under
      MIRR

Lawn Depot, Inc.


            SML EQUATION
     All the figures were provided by
      Ibbotson
  Associates.
     KS = KRF + (KM - KRF)b
     6 + (12 - 6) 1.4
  = 14.4%


Lawn Depot, Inc.


           BEST ESTIMATE
     Cost of Equity used in WACC found
      using DCF (16.6%)
   By using CAPM, Cost of Equity is
    14.4%
   Which method is superior?
   Company has only been public for
    10 years, the
    Beta                         estimate
    is probably innacurate
   Beta more accurate for longer
    periods of time, converges toward 1
   The company probably in specific
    growth stage

								
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