Response to Classmates Discussions
kingstonman41
Week3Discussion2ClassmatesResponse.docxWeek 3 - Discussion Forum 2
Guided Response: Respond to at least three of your fellow students’ or instructor posts in a substantive manner and provide information or concepts that they may not have considered. Each response should have a minimum of 100 words and be respectful of others’ opinions and beliefs that differ from your own. You are encouraged to post your required replies earlier in the week to promote more meaningful and interactive discourse in this discussion forum. Continue to monitor the discussion forum until Day 7 and respond with robust dialogue to anyone who replies to your initial post.
On this Document there three classmates that needs to be respond to they are Lisa Schreiner , Ashley Thiberville , and Jamie Choate
. Please provide reference to your response if any
Lisa Schreiner
Jul 10, 2020Jul 10 at 5:42pm
The weighted average cost of capital (WACC) and capital allocation are essential functions of any business investing assets through various funding vehicles. The article I chose to review is Cost Allocation for Capital Budgeting Decisions. This article addresses the importance of comparing the benefits to the cost of a project to determine if the plan will move forward (Baldenius et al., 2007). Additionally, the authors point to processes for comparison when a project benefits a single department or multiple departments, sharing the assets and driving savings to increase cash flow (Baldenius et al., 2007). For example, upgrading software access from servers to the cloud. This is not only an IT savings but spans company wide. Reducing the need for physical servers, upgrades to versions and capacity, man hours to maintain, and the need to store and secure such equipment. Balendius et al. (2007) discusses a hurdle rate set by the organization as a risk threshold to measure strength and positive contributions a capital project will provide in return. This hurdle rate is used in the decision making process and is equivalent to the acceptable weighted point under the WACC evaluation.
The WACC calculation provides an organization with the percentage of debt comparative to equity used to fund capital asset purchases, identifying a point where an increase in debt will prove too risky for a company (Block et al., 2019). Heavily leveraging debt to fund asset purchases will reflect a poor debt to equity ratio and the inability to produce cash flow through operating profitability. These negative reflections will increase debt interest rates, decrease investor interest, and could push the organization into bankruptcy.
References
Baldenius, T., Dutta, S., & Reichelstein, S. (2007). Cost Allocation for Capital Budgeting Decisions. Accounting Review, 82(4), 837–867. https://doi-org.proxy-library.ashford.edu/10.2308/accr.2007.82.4.837 (Links to an external site.)
Block, S. B., Hirt, G. A., & Danielsen, B. R. (2019). Foundations of financial management (17th ed.). https://www.vitalsource.com (Links to an external site.)
Ashley Thiberville
WednesdayJul 15 at 4:37pm
Covanta is a waste management company that recently released a statement addressing their current capital allocation plans amid the COVID-19 pandemic. The company plans to reduce impacts through various short- and long-term programs to help protect long term values for shareholders. The long-term plans focus on eliminating non-essential travel, lowering compensation rates for upper management through a graduated program that starts with the CEO, and accelerating balance sheet improvement (Waste360, 2020). Covanta’s capital reallocation response to COVID-19 impacts aligns with the text’s view of capital allocation because the company is weighing its capital components against the impacts of the pandemic and finding ways to achieve a, “minimum overall coast of capital,” (Block et al, 2019).
Covanta is also weighted average cost of capital (WACC) calculations to weigh debt against the risks faced by the company (Block et al, 2019). Covanta plans scale back expansion projects and focus solely in the UK in 2020, while COVID-19 impacts remain high (Waste360, 2020). The company remains aware of impacts and recognizes that taking an additional debt in uncertain times could lead to too much financial risk for the company.
Block, S. B., Hirt, G. A., & Danielsen, B. R. (2019). Foundations of financial management (17th ed.). Retrieved from https://www.vitalsource.com
Waste360. (2020). “Covanta Business and Capital Allocation Update.” Covanta Holding Corp. https://bi-gale-com.proxy-library.ashford.edu/global/article/GALE%7CA622102320?u=ashford#page=1&q=advDocumentTitle^Covanta%20Provides%20Business%20and%20Capital%20Allocation%20Update.&q=advPublicationTitle^Waste360%20(Online)^and&limiters=pubDate^20200415 (Links to an external site.)
Jamie Choate
WednesdayJul 15 at 8:13pm
Financial capital consists of bonds, preferred stock and common equity. Firms must find a balance between debt and equity to achieve its minimum cost of capital (Block, Hirt, & Danielsen, 2019). Once this is determined, the weighted average cost of capital is the discount rate used in PV future flows to ensure that the company is earning an amount that is at least equal to the cost of financing (Block, Hirt, & Danielsen, 2019).
The article I read focused on the motives behind capital allocation including maximization of business unit and firm growth, risk mitigation, and the exploitation of synergies through leveraging and sharing of capabilities and assets across business units. The first motive is known as winner picking and involves allocating capital to those with the BUs that have the best business performance. The second motive is around diversification where capital is allocated to multiple business units, related and unrelated, to maximize the scope of product offerings. The third motive involves exploiting synergies amongst BUs by sharing, lending, leveraging resources, capabilities, and expertise. What determines successful capital allocation and states that it can not be based on one perspective that in order to put the puzzle together you have to understand the purpose and what the firm is trying to accomplish. The article also focused on the efficiency of capital allocation which is focused on input to output ratio comparison. Capital allocation efficiency looks at each business unit and determines the relationship between that BUs performance and the amount of capital it receives. It also examines the difference between external and internal efficiency views.
This article was different from what the textbook teaches us. The textbook looks at determining capital allocation on the weighted average cost of capital to determine the optimum capital structure. It fails to recognize the strategy of the business or the motives behind capital allocation and how they balance where in the business capital is invested. It strictly defines success as minimizing the cost of capital and maintaining a balance within a predefined range.
Since the article focused more on internal capital allocation and how capital is distributed across a firm, it did not reflect on WACC. However, I did research this further and the lower the cost of capital, the greater the present value of a firm and while debt to equity ratios are not what is necessarily fully regarded when optimizing capital, investors do still view this number more heavily than the WACC of the company (Hayes, 2020). Investors will put their money into companies with strong balance sheets that reflect lower levels of debt and higher levels of equity.
One example of successful capital allocation is with the CFO at Intuit, Inc. The CFO emphasized the importance of a disciplined capital allocation approach. This approach managed internal spending, acquisition investment, and returning money to the shareholders. They were able to return 15% over a 5 year period. The disciplined approach should keep managers focused and should prioritize the allocations based on what brings the best return and has the biggest impact across the company. According to the CFO, there are three areas that capital allocation should focus on; investing in your business for optimal growth with both customers and revenue, investing in acquisitions that fuel top-line growth with companies that produce similar products, and investing in what has the ability to return the greatest amount to shareholders (Cash Management, 2015).
References:
Busenbark, Wiseman, Arrfelt, & Woo. (2017, October 17). A Review of the Internal Capital Allocation Literature: Piecing Together the Capital Allocation Puzzle. Journal of Management, vol. 43, 8: pp. 2430-2455. Research Article https://doi-org.proxy- library.ashford.edu/10.1177/0149206316671584
Block, S. B., Hirt, G. A., & Danielsen, B. R. (2019). Foundations of financial management (17th ed.) . Retrieved from https://www.vitalsource.com
Cash Management. (2015, December 10). Capital Allocation Principles Stand the Test of Time. Retrieved from https://www.cfo.com/cash-management/2015/12/capital-allocation-principles-stand-test- time/
Hayes, A. (2020, July 5). Optimal Capital Structure. Retrieved from https://www.investopedia.com/terms/o/optimal-capital- structure.asp#:~:text=The%20lower%20the%20cost%20of,the%20company%20(shareholder%2 0wealth).
