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The Vioxx recall resulted in loss of trust with lenders and a higher required return with...

The Vioxx recall resulted in loss of trust with lenders and a higher required return with shareholders. As a result the cost of capital increased for Vioxx. What affect does this increase have on future projects and capital investments for the company?  talk about the impact of cost of capital to the financial strength of Vioxx and the consequences for stakeholders (not just shareholders) as well.?

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Solution:

The cost of capital has been increased due to the Vioxx recall.

The weighted average cost of capital has two components - Equity and debt

The WACC has increased so it is due to the increase in return on equity and debt. WACC is used to calculate the NPV of the project and take decison based on that. If WACC is increased then the NPV will go down and due to this there might be some chance that the project that was having positive NPV earlier now gives negative NPV.

Impact on future Project: The NPV wil decrease and project might become unviable

Capital investment: Capital investment will become more tougher as the return should be greater than the earlier case due to increase in WACC

Impact of cost of capital: The WACC is used for the project appraisal and it is important for both the equity holder and debt holder because they will be paid with the returns generated from the project and higher WACC will make it difficult

jeff jeffy answered 2 years ago
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