Quantile Capital: What Should This Project Have to Beat?
Quantile Capital is a asset management business in UK. The board is being asked to approve a £116 M capacity expansion that the sponsoring team says will return 14.1%.
The CFO has been using a flat 12% hurdle rate for every proposal for the last four years. A new board member has challenged that, pointing out the capital structure has shifted and rates have moved since it was set.
Current position: the company is funded 30% debt and 70% equity. It borrows at 10.6% pre-tax and pays a 30% effective tax rate. The equity beta is 0.98, the risk-free rate is 6.2%, and the equity risk premium in this market is taken as 5.8%.
The project has roughly the same operating risk as the existing business.
proposal
- size m
- 116
- claimed return pct
- 14.1
- legacy hurdle rate pct
- 12
cost inputs
- equity beta
- 0.98
- risk free rate pct
- 6.2
- effective tax rate pct
- 30
- equity risk premium pct
- 5.8
- pre tax cost of debt pct
- 10.6
derived hints
- wacc pct
- 10.54
- cost of equity pct
- 11.88
- after tax cost of debt pct
- 7.42
capital structure
- debt pct
- 30
- equity pct
- 70
Advise the board. Your answer should provide:
- Analysis — compute the cost of equity, the after-tax cost of debt, and the blended WACC. Show the arithmetic.
- Risks — what the single-hurdle-rate approach gets wrong, and what would move your number.
- Recommendation — the hurdle rate you would set and whether this project clears it.
State any assumptions you make.
80 points, 60% to pass.
- recommendation20
- market analysis15
- risk assessment20
- financial analysis25
Reveal suggested structure
CAPM for cost of equity, after-tax cost of debt, weight by capital structure, compare project return to WACC, then sensitise.