Problem 12.

1 Novo's cost of equity prior to April 1980

What was Novo's cost of equity?

Assumptions Values
Danish risk free rate of interest, krf 10.00%
Danish stock market return, km 18.00%
Novo's beta before internationalization 1.00

What was Novo's cost of equity?

ke = krf + ( km - krf ) β 18.00%

Problem 12.2 Novo's WACC prior to April 1980
What was Novo's weighted average cost of capital?

Assumptions Values
Novo's cost of debt, kd 12.0%
Novo's cost of equity, ke 18.0%
Novo's debt to capital ratio, D/V 70.0%
Novo's equity to capital ratio, E/V 30.0%
Novo's effective tax rate, t 40.0%

a) What was Novo's weighted average cost of capital?

WACC = (D/V x kd (1-t)) + (E/V x ke) 10.44%

b) How did this affect its capital budget?

The relatively high debt ratio and the tax shelter of interest led to a modest
WACC despite the relatively high cost of equity. Thus the WACC was
probably a reasonable hurdle rate for capital investments. However, as
explained in Chapter 11, the bigger problem was that the marginal cost of
capital would increase significantly if Novo did not gain access to the
liquidity provided by international portfolio investors.
Problem 12.3 Novo's cost of equity after July 1981
What was Novo's cost of equity?

Assumptions Values
International risk free rate of interest, krf 8.00%
International stock market return, km 12.00%
Novo's beta after internationalization 0.80

What was Novo's cost of equity now?

ke = krf + ( km - krf ) β 11.20%

This was a very significant drop from the 18% cost of equity observed
before April 1980.
Problem 12.4 Novo's WACC after July 1981
What was Novo's weighted average cost of capital?

Assumptions Values
Novo's new cost of debt, kd 10.0%
Novo's cost of equity, ke 11.2%
Novo's debt to capital ratio, D/V 50.0%
Novo's equity to capital ratio, E/V 50.0%
Novo's effective tax rate, t 40.0%

a) What was Novo's weighted average cost of capital?

WACC = (D/V x kd (1-t)) + (E/V x ke) 8.60%

b) How did this affect its capital budget?

The lower cost of equity more than offset the lower debt ratio. The WACC
was reduced to 8.60% from 10.44%. This created a better hurdle rate for
capital investments. Furthermore, access to international portfolio investors
improved Novo's marginal cost of capital. Both results increased the number
of capital projects that could be undertaken by Novo.
Problem 12.5 Novo's cost of equity in 2003
What was Novo's cost of equity?

Assumptions Values
International risk free rate of interest, krf 4.00%
International stock market return, km 8.00%
Novo's beta after internationalization 0.80

What was Novo's cost of equity now?

ke = krf + ( km - krf ) β 7.20%

This is a further drop in the cost of equity due to reduced market

expectations in much of the world and lower interest rates.
Problem 12.6 Novo's WACC in 2003
What was Novo's weighted average cost of capital?

Assumptions Values
Novo's new cost of debt, kd 6.0%
Novo's cost of equity, ke 7.2%
Novo's debt to capital ratio, D/V 50.0%
Novo's equity to capital ratio, E/V 50.0%
Novo's effective tax rate, t 40.0%

a) What was Novo's weighted average cost of capital?

WACC = (D/V x kd (1-t)) + (E/V x ke) 5.40%

b) How did this affect its capital budget?

Novo's lower WACC in early 2003, compared to post-July 1981, was mainly
due to lower overall interest rates and required rates of return. Theoretically,
Novo's lower WACC should lead to even more acceptable capital projects.
However, the dismal economic outlook worldwide in early 2003 discouraged
firms from investing in capital projects even though they pass the new lower
hurdle rate.
Problem 12.7 HangSung before equity issue abroad
What was HangSung's cost of equity?

Assumptions Values
Korean risk free rate of interest, krf 10.00%
Korean stock market return, km 14.00%
HangSung's beta 1.00

What was Novo's cost of equity now?

ke = krf + ( km - krf ) β 14.00%

Problem 12.8 HangSung's WACC before equity issue abroad
What was HangSung's WACC?

Assumptions Values
HangSung's cost of debt, kd 12.0%
HangSung's cost of equity, ke 14.0%
HangSung's debt to capital ratio, D/V 80.0%
HangSung's equity to capital ratio, E/V 20.0%
HangSung's effective tax rate, t 30.0%

What was HangSung's WACC?

WACC = (D/V x kd (1-t)) + (E/V x ke) 9.52%

Problem 12.9 HangSung after equity issue abroad
What was HangSung's new cost of equity?

Assumptions Values
International risk free rate of interest, krf 4.00%
International stock market return, km 8.00%
HangSung's beta 0.70

What was Novo's cost of equity now?

ke = krf + ( km - krf ) β 6.80%

The cost of equity dropped significantly from 14% to 6.8% after the
equity issue abroad. This demonstrates one of the advantages for a firm
to internationalize its cost and availability of capital.
Problem 12.10 HangSung's WACC after equity issue abroad
What was HangSung's WACC in 2003?

Assumptions Values
HangSung's cost of debt, kd 6.0%
HangSung's cost of equity, ke 6.8%
HangSung's debt to capital ratio, D/V 60.0%
HangSung's equity to capital ratio, E/V 40.0%
HangSung's effective tax rate, t 30.0%

a) What was HangSung's WACC?

WACC = (D/V x kd (1-t)) + (E/V x ke) 5.24%

b) How did this affect its capital budget?

HangSung's WACC was lowered from 9.52% before its equity issue abroad
to 5.24% aftewards. This should lead to more acceptable capital projects.
The equity issue abroad should also increase HangSung's liquidity, thereby
leading to a less-steeply increasing marginal cost of capital and still more
acceptable capital projects.