I’m studying and need help with a Business question to help me learn.
Cost of Capital
In the links below, you will explore how companies compute their cost of capital by computing a weighted average of the three major components of capital: debt, preferred stock, and common equity. The firm’s cost of capital is a key element in capital budgeting decisions and must be understood in order to justify capital projects.
For this Discussion, imagine the following scenario:
You are the director of operations for your company, and your vice president wants to expand production by adding new and more expensive fabrication machines. You are directed to build a business case for implementing this program of capacity expansion. Assume the company’s weighted average cost of capital is 13%, the after-tax cost of debt is 7%, preferred stock is 10.5%, and common equity is 15%. As you work with your staff on the first cut of the business case, you surmise that this is a fairly risky project due to a recent slowing in product sales. As a matter of fact, when using the 13% weighted average cost of capital, you discover that the project is estimated to return about 10%, which is quite a bit less than the company’s weighted average cost of capital. An enterprising young analyst in your department, Harriet, suggests that the project is financed from retained earnings (50%) and bonds (50%). She reasons that using retained earnings does not cost the firm anything since it is cash you already have in the bank and the after-tax cost of debt is only 7%. That would lower your weighted average cost of capital to 3.5% and make your 10% projected return look great.
Based on the scenario above, post your reactions to the following questions and concerns:
What is your reaction to Harriet’s suggestion of using the cost of debt only? Is it a good idea or a bad idea? Why? Do you think capital projects should have their own unique cost of capital rates for budgeting purposes, as opposed to using the weighted average cost of capital (WACC) or the cost of equity capital as computed by CAPM? What about the relatively high risk inherent in this project? How can you factor into the analysis of the notion of risk so that all competing projects that have relatively lower or higher risks can be evaluated on a level playing field?
400 words references and APA format
Requirements: .doc file | Discussion | 1 pages, Single spaced
We value our customers and so we ensure that what we do is 100% original..
With us you are guaranteed of quality work done by our qualified experts.Your information and everything that you do with us is kept completely confidential.
You have to be 100% sure of the quality of your product to give a money-back guarantee. This describes us perfectly. Make sure that this guarantee is totally transparent.Read more
The Product ordered is guaranteed to be original. Orders are checked by the most advanced anti-plagiarism software in the market to assure that the Product is 100% original. The Company has a zero tolerance policy for plagiarism.Read more
The Free Revision policy is a courtesy service that the Company provides to help ensure Customer’s total satisfaction with the completed Order. To receive free revision the Company requires that the Customer provide the request within fourteen (14) days from the first completion date and within a period of thirty (30) days for dissertations.Read more
The Company is committed to protect the privacy of the Customer and it will never resell or share any of Customer’s personal information, including credit card data, with any third party. All the online transactions are processed through the secure and reliable online payment systems.Read more
By placing an order with us, you agree to the service we provide. We will endear to do all that it takes to deliver a comprehensive paper as per your requirements. We also count on your cooperation to ensure that we deliver on this mandate.Read more