Lawn Depot Case

Lawn, Inc. – Capital Budgeting

1. Lawn Depot’s market value capital structure is as follows:

Cost of Capital components –

L/T Debt = $310 → Wd=50%

P/S = $145 → Wps=24%

S/T Debt = $50 → Wsd=8%

CE = $110 → Wre=18%

Total = $615

Cost of Debt = YTM(1-T) = .08(1-.40) = 4.8%

Cost of Preferred Stock = D/P(1-F) = $9/$100(1-.10) = 10%

Cost of Retained Earnings = D/P+g = $10/$60+0 = 16.6%

Cost of S/T Debt = YTM(1-T) = .07(1-.40) = 4.2%

Cost of New Common Stock = D/P(1-F) = $10/$60(1-.20) = 20.83%

WACCre = KdWd+KpsWps+KreWre+KsdWsd

        = 4.8%(50%)+10%(24%)+16.6%(18%)+4.2%(8%)

        = 8%

WACCncs = 12.5%(1-.40)(50%)+10%(24%)+20.83%(18%)+4.2%(8%)

                                 = 10.24%

1. Breakpoint = Retention Ratio → (1-Div. Payout)(RE)/Wre + Depreciation

= (1-.60)(80M)/18% = 177.78 + 60M depreciation = $237.78M

       3.

Component                Weight                $0-$124M                Over $124M

LT Debt                50%                        4.8% =.2.4%                7.5% = 3.75%

ST Debt                8%                        4.2% = .336%                2% = .16%

Pfd Stock                24%                        10% = 2.4%                10% = 2.4%

Common Eq                18%                        16.16% = 2.9%        20.83%=3.75%        

                                                8%                        10.06%

** DRAW MCC SCHEDULE

4a.   The internal rate of return for Project A* is 20%, based on the cost of the project   being $30 and the estimated annual cash inflows for 8 years is $7.81.

** DRAW IOS AND MCC SCHEDULE

      4b.   All of the projects’ IRRs are higher than the WACC, so we accept them all. Projects A and A* are mutually exclusive projects, and the IRRs of both exceed the cost of capital. However, the NPV of project A is greater than that of project A*. Therefore, we accept project A since they are mutually exclusive and its NPV is higher, and we accept project B since the IRR is higher than the WACC.