FIN622 GDB No. 02 Corporate Finance Course Last Date: 25-06-2013

FIN622 Corporate Finance Course GDB No. 02 Solution and Discussion Spring 2013 Due Date: 25-06-2013Learning objectives:Students will be able to: Understand the use of weighted average cost of capital (WACC) in evaluating investment options Evaluate investments with risk level different from firms’ average risk Learning outcomes: After this discussion students will learn: Where to use weighted average cost of capital (WACC) as an appropriate evaluation benchmark Case: ABC is all equity financed company operating in textile sector for 10 years and enjoying handsome share in industry profits. Management is deciding to diversify its business by investing into one of the most growing industry i.e. fashion industry for which they are considering two investment options. Fashion industry is quite uncertain because of rapid change in the trends, changing demands of the customers, intensive competition and economic factors. Management has decided to use its weighted average cost of capital (WACC) to evaluate the investments. Cost of equity for company ABC is 18% whereas beta is 1. Investment A is offering 19% return with beta of 1.8 whereas investment B is offering 17% return with beta of 1.10. Risk free rate of return is 12% and market is offering 16% return on such type of investments. Required: Which investment option will be rejected if company use its existing WACC to evaluate two investments? Give logical reasoning to support your answer. How this uncertain environment of Fashion industry can affect acceptance or rejection of investments if company uses its existing WACC to evaluate investments and how Company will adjust its WACC for Fashion Industry? Give logical reasoning to support your answer.