Self Case - Student Educational Loan Fund, Inc.

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Case 2: Analysis of Alternatives

Student Educational Loan Fund, Inc.

Institution: University Gadjah Mada
Program: Master of Management

Course: Risk Management
Tutor: Mrs. Erni Ekawati, PhD.

Title: Case 2: Analysis of Options
Subtitle: Student Educational Loan Fund, Inc.

Date: November 17, 2008
Place: Yogyakarta

Authors: Martin Koopman Doddy Handaryadi Anindito Prabowo Gumirlang Wicaksono


This report describes the situation which Rick Melnick faces in the fall of 1995, when assuming the responsibilities as Associate Director of Financial Management at Harvard Business School (HBS) (Ekawati, 2008). Rick had to oversee the Student Educational Loan fund (SELF), analyze a change of plans and
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In the future, SELF will be able to set limits on their cost of debt, by using some of the available alternatives (see next chapter). Furthermore, we know that the limits on the debt ratio are 4 to 1, in comparison with the net worth of SELF. Interpreting this, we assume that SELF may have a maximum of 80% debt, with 20% equity in their capital structure (4 to 1). The current Prime-rate is 8,75% and will be used as a basis to calculate the possible WACC for SELF. Assuming that the debt rates are before tax, we will subtract a tax rate of 30% on the debt rates, resulting in:

WACC = {(D/E+D)*[Cd*(1-0,30)] + (E/E+D)*(Ce)} (Saunders & Cornett, 2008)

WACC max (with 100% equity) = {(0/100)*[8,75*(0,70)] + (100/100)*(10)} = 10%

WACC min (with 80% debt) = {(80/100)*[8,75*(0,70)] + (20/100)*(10)} = 6,9%

Since SELF will still be exposed to a default risk of some percentage (lets say 1,00% instead of 1,40%) and we believe that it is unlikely that SELF will ever reach an equity level of 100%, we think that the WACC should be adjusted to show a more realistic number. For example, historically the Prime-rate or LIBOR has also reach levels of approximately 10% (Ekawati, 2008), thereby increasing the minimum WACC to about 10%. Although this situation is less likely, since SELF is a non-profit organization, we believe it should include these scenarios into their calculation of WACC as well. If we then also include
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