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Sterling Household Products Essay
1493 WordsSep 29th, 20146 Pages
Sterling Household Products Company
Acquisition of the Germicidal, Sanitation and Anitseptic Unit of Montagne Medical Instruments Company Executive Summary
Sterling Household Products Company manufactured and marketed a wide variety of consumer goods products which were sold domestically as well internationally. Despite having great products and being positioned well in the industry, Sterling’s growth prospects were limited. Sterling’s decision to acquire the germicidal, sanitation and antiseptic production unit of Montagne Medical Instruments Company could provide the much needed growth. Furthermore, the division was well aligned with Sterling’s existing operations, helping Sterling diversify its business without compromising on…show more content…
the sale of germicidal, sanitation, and antiseptic products for health care uses. However, the beta given in the appendix is the levered beta, which we have converted to unlevered beta and then averaged the unlevered beta of the two comparable companies. This unlevered beta has then been applied to the proposed capital structure of 30% debt and 70% equity. This is the unlevered beta of the unit under consideration. This is then converted to calculate the levered project beta as 0.936. The levered beta for Chiron is 0.85 and for pathogen is 0.90. This means that Montagne Medical Instruments Company's germicidal, sanitation, and antiseptic products unit carries more business risk compared to its competitors’ viz. Chiron and Pathogen.
Cost of equity
The cost of equity is the theoretical return that equity investors expect or receive from the company for investing their funds in the company. The risk free rate that is the Government Treasury bill rate is 3.1%, the market risk premium is 7% and the beta has been calculated as
0.94. Using the capital asset pricing model, the cost of equity comes to 9.65%.
Rf Beta (Project) MRP Cost of Equity
3.10% 0.94 7% K (e) = K (rf) + beta (project) * MRP K(e) = 9.65%
The firm has decided to increase the debt finance component portion from 20% to 30% which is a good decision since the interest payments are 100% tax deductible. The appropriate capital structure would be to