Ferrari Corp., an automotive producer with a current debt-to-equity ratio of 3, is considering expanding its operations to produce bicycles. Unsurprisingly, the bicycle industry faces a different set of risks than the automotive industry. However, the executives at Ferrari Corp. observe that Bikes Inc., a bicycle company, has a cost of equity of 14%, a cost of debt of 6%, and a debt-to-value ratio of 40%. Ferrari plans to finance its expansion into bicycle production with 50% debt and 50% equity. The cost of debt for Ferrari is 8%, and the corporate tax rate is 25%. Solve for the discount rate that Ferrari Corp. should use when evaluating whether to go forward with the expansion.
Financial Ratios
A Ratio refers to a figure calculated as a reference to the relationship of two or more numbers and can be expressed as a fraction, proportion, percentage, or the number of times. When the number is determined by taking two accounting numbers derived from the financial statements, it is termed as the accounting ratio.
Return on Equity
The Return on Equity (RoE) is a measure of the profitability of a business concerning the funds by its stockholders/shareholders. ROE is a metric used generally to determine how well the company utilizes its funds provided by the equity shareholders.
Ferrari Corp., an automotive producer with a current debt-to-equity ratio of 3, is considering expanding its operations to produce bicycles. Unsurprisingly, the bicycle industry faces a different set of risks than the automotive industry. However, the executives at Ferrari Corp. observe that Bikes Inc., a bicycle company, has a
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