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Here, you are required to estimate the cost of capital for HCL and identify and explain any potential problems with this approach in the situation given below. You are required to gather all the required information for weighted average cost of capital for Harvey Norman.
COST OF CAPITAL FOR HUBBARD COMPUTER LTD - (2500 words)
You have recently been hired by Hubbard Computer Ltd (HCL), in its relatively new treasury management department. HCL was founded eight years ago by Bob Hubbard and currently operates 14 stores in the South Island of New Zealand. HCL is privately owned by Bob and his family, and had sales of $9.7 million last year.HCL primarily sells to in-store customers who come to the store and talk with a sales representative. The sales representative assists the customer in determining the type of computer and peripherals that are necessary for the individual customer’s computing needs. After the order is taken, the customer pays for the order immediately, and the computer is made to fill the order. Delivery of the computer averages 15 days, and it is guaranteed in 30 days.
HCL’s growth to date has been financed by its profits. When the company had sufficient capital, it would open a new store. Other than scouting locations, relatively little formal analysis has been used in its capital budgeting process. Bob has just read about capital budgeting techniques and has come to you for help. For starters, the company has never attempted to determine its cost of capital, and Bob would like you to perform the analysis. Since the company is privately owned, it is difficult to determine the cost of equity for the company. Bob wants you to use the pure play approach to estimating the cost of capital for HCL, and he has chosen Harvey Norman as a representative company. The following steps will allow you to calculate this estimate.
5. You used Harvey Norman as a pure play company to estimate the cost of capital for HCL. Are there any potential problems with this approach in this situation? (10 Marks)