Please respond if you can answer in 15 hours

Total 900 words( please follow instructions carefully)

Write 450 words for the main topic(Cost of Capital) and respond to three articles with 150 words each.

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.

https://www.youtube.com/watch?v=B8JZhQofRTs

For this Cost of Capital 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?

3 Responses

Instructions

In your response to the discussions posted, consider comparing cash generation techniques at your company versus his or her company. Draw distinctions based on the industry and tell your colleagues why those distinctions are necessary for the management of cash flow.

Below are additional suggestions on how to respond to discussions:

· Ask a probing question, substantiated with additional background information, evidence or research.

· Share an insight from having read your colleagues’ postings, synthesizing the information to provide new perspectives.

· Offer and support an alternative perspective using readings from the classroom or from your own research.

· Validate an idea with your own experience and additional research.

· Make a suggestion based on additional evidence drawn from readings or after synthesizing multiple postings.

· Expand on your colleagues’ postings by providing additional insights or contrasting perspectives based on readings and evidence.

1) Respond to 1st article with 150 words

Capital expense is the required return needed to make a capital budgeting initiative worthwhile, such as constructing a new plant. Usually, as owners and statisticians discuss the cost of money, they say the weighted average of the debt and equity costs of a business combined together. The cost of the capital calculation is used collectively by businesses to assess if the expense of resources is about a capital project and by creditors who use it to assess if a project is worth the risk as opposed to the return. Capital costs depend on the method of funding used. It applies to the equity cost if the corporation is funded solely by equity, or to the debt expense if it is creating the actual by debt (Sharma, 2020).

Whatever ideas Harriet proposes is not good for the latest project and the key explanation is that borrowing even more from the wallets of investors will lead to unpredictable problems and feel discouraged from investors as well. Investors and vendors could still fear about the company's current financial situation if they blindly obey the recommendations made by Harriet to use only debt. The use of corporate leverage has some tax advantages for the corporation, but it can also provide the corporation with higher returns and lower returns than anticipated.

Companies always ensure that they hold enough financial capital so that, particularly after uncertain events, they can run the day-to-day activities of the companies. It may trigger financial disruptions and other unpredictable problems if the organization struggles to sustain sufficient cash flows. The cost of capital can be used as the Weightage Average Cost of Business (WACC) as it weighs the cost of capital used and debt used (Pierre, 2014). Taking the high risk of ventures may have a comparable effect on potential cash flows and unpredictable financial shocks. The definition of risk in ventures can be determined by the cost of resources used.

References:

Pierre A (2014). The weighted average cost of capital is not quite right: A comment. Q. Rev. Econ. Finance. 49:1219-1223.

Sharma, D. S., Sharma, V. D., Tanyi, P. N., & Cheng, X. (2020). Should Audit Committee Directors Serve on Multiple Audit Committees? Evidence from Cost of Equity Capital. Auditing: A Journal of Practice & Theory, 39(2), 185–205. https://doi.org/10.2308/ajpt-17-117

2) Respond to 1st article with 150 words

There are many organizations is having a huge amount of money for sale in cash inside their stability sheet by me it is a tremendously proven fact that is good the cash as cost for capital investment that is what Harriet's has mentioned this is the quantity that the organization already received spending that money as being a cost for capital for the next project really helps to expand the organization's company. The top management techniques perform a key part in determining the opportunities of the specific organization. There's also another very important component is whenever an organization plans on investment they need to have a typical procedure for assessing those comes back also they need certainly to assess most of the possibilities fairly. It’s always not the case to adhere to the WACC everybody knows that organization uses this to gauge the total amount that organizations will pay back to its stakeholders for making use of the assets and also this is used mainly for the capital cost for organizations. Capital budgeting is centered on what type of investment it really is and the comes back additionally ought to be determined based on the kind of investment and so I indicate each project needs its means that is very own regarding the return. An essential thing I might constantly recommend organizations have various plan for every single capital budget investment because constantly having a typical formula for the cost management purpose does not work because in every investment you will have a risk element often to conquer that risk there could possibility of spending more income for the prosperity of that project (Hinkel & Hoffman, 2020).

In this complete instance, you will have an increased budget for the conclusion of the project so that the expected capital with all the CAPM or WACC will never be accurate. Even though those directions claim that having an approach that is significantly different from cost management just isn't allowed but are of good use. Cost of capital is really a key thing that organizations look at because that's the investment expenses they will have on any new projects it is additionally the total amount that organizations has to return because this is the initial investment the organizations make a good example is creating a new factory or finding a new equipment for the organization therefore since it’s a good investment our company is making to ensure that organization can gain straight back that profit future often organizations could make more comes back using this investment so it can increase the manufacturing, here is the capital investment that business use therefore in cases like this there's also risk included. In the event of new opportunities the organizations sometimes can’t even make their capital and there exists a huge risk active in the startups nevertheless they can earn significantly more returns when considering to your capital organizations likewise have a few metrics determine before their assets if they're effective. The risk is definitely proportional to your comes back in just about any capital budgeting of an organization (Levi & Welch, 2017).

References

Hinkel, T. P., & Hoffman, B. W. (2020). Meeting Earnings Benchmarks via Real Activities Manipulation: Debt Market Effects. Journal of Accounting, Auditing & Finance, 35(2), 349–378.

Levi, Y., & Welch, I. (2017). Best Practice for Cost-of-Capital Estimates. Journal of Financial & Quantitative Analysis, 52(2), 427–463. https://doi.org/10.1017/S0022109017000114

3) Respond to 1st article with 150 words

Conferring to the argument, I bring into being that the suggestion provided by Harrier to clear the debts such that the company has a privilege to pay less amount of tax was good. In this context the company is paying the debts at the rate 7% to the bank which is a critical situation for the company as it might lose its finance and investors at regular basis. Thus, it is better for a company to have debts at less interest as it will allow company to pay less taxes and it can clear the debts to the bank at timely manner and can have a good margin of profit and can get good investors for the company (corporatefinanceinstitute.com, 2020).

The method in which the whole capital is calculated in a company and are measure in a proportional manner is called WACC or Weighted Average Cost of Capital. This method is furthermore described as the capital of the company that has stocks, links and sum unpaid included in which they has to calculate everything. By calculating the financial understanding comes to an ease when it comes to the investors. This makes the investors understand the company’s financial state and can make a start making investments towards the organization.

Thus, this technique is implemented by the investors in order to get the proper information on Rate of investments and can predict the success rates of the project. Thus, this method is considered to be a good method to be followed by the investors. For the survival in the market, the company must ensure that there are no glitches when it comes to financial management or else the company might stand at a huge risk. Thus, the company must analyse the risks from the very beginning of the projects. These risks might also be due to the misconception from the consumers. Thus, company must be able to handle the risks before it causes any negative impact on the company (Jacobs et al, 2012).

References

corporatefinanceinstitute.com. (2020). Cost of Capital. Retrieved from, https://corporatefinanceinstitute.com/resources/knowledge/finance/cost-of-capital/

Jacobs et al. (2012). Do You Know Your Cost of Capital? Retrieved from, https://hbr.org/2012/07/do-you-know-your-cost-of-capital