Enzone Petroleum Corporation

CASE CONTEXT:

* Formed in1924 with the merger of several formerly independent firms operating in the oil refining, pipeline transportation, and industrial chemical fields.

* All computations were based in 1975 data

PROBLEM:

* Determination of a minimum acceptable rate of return on new capital investments in 1975.

* Should the company adopt a system of multiple cutoff rates?

FRAMEWORK OF ANALYSIS:

* WACC

* Return on Assets

* Cost of Common stock equity

ANALYSIS:

The management of Enzone Company is in a debate of whether to use the constant minimum rate for evaluating operations and investments, 10% since 1966, or have multiple cutoff rates per division. They also believe that rates should already be adjusted because of inflation and different market inefficiencies. Also, they argue that risk return relationship will be more effective using multiple rates for the different divisions because each one employs a unique level of risk. Proponents of both sides gave their arguments and all have its points.

DECISION:

Based on the data provided, we decided that the company should implement a single rate of return, from 10% to the adjusted rate of return of 12.22%. Also, its weighted cost of capital should also be adjusted from 8.25% to 10.28%.

JUSTIFICATION:

New after tax cost Weighted cost

Debt 25% 4.45% 1.1125

Retained earnings 65% 12.22%