Question

Page 360, Questions 1, 3-4

1)What are some economic factors that motivate leasing-that is what asymmetries might exist that make leasing beneficial to both lessors and lessees?

3) Does leasing lead to increased credit availability?

4) What is your reaction to this statement: “ leasing is preferable to buying because it preserves the business’s liquidity”?

Chapter 9

Page 371, Questions 1-2

1)What is the basic concept of the corporate cost of capital?

2)What financing sources are typically included in a firms cost of capital estimate?

Page 374, Question 1

What are some methods used to estimate a business’s cost of debt?

Page 388, Question 1, 3, 7 and 8

1)Describe the CAPM approach to estimating a business’s cost of equity

3)What are the three types of beta that can be used in the CAPM?

7)Is there a difference in the deb-cost plus risk premium model?

8) How would you choose among widely different estimates of R(Re)?

Page 394 Questions 1-2

1) What is the general formula for finding the CCC?

2)What weights should be used in the formula? Why?

Page 396, Question 1

1) Explain the economic interpretation of the CCC?

Page 399, Question 1

1) Explain the concept of divisional costs of capital.

Page 404, Question 1

1) What are the factors that affect the CCC estimate?

Answer 1

Chapter 9 - Page 371

Answer to Q1 :

Cost of capital is the return expected by the providers of the capital (i.e. Share holders, lenders and debt providers).

Where an entity obtains money from any of the aforesaid sources, the entity has to pay some additional amount of money in addition of principal amount. This additional money paid is said to be the cost of using the capital and is called the 'cost of calpital'. The cost of capital generally expressed in rate is used to discount/compound the cashflows and is also called as cut-off rate, hurdle-rate or 'minimum rate of return'.

The cost of capital is important to arrive at management decisions in terms of estimation of benefits from available investment opportunities by discounting the cashflows using Cost of capital rate. Cost of capital is also used to appraise the business performance.

Answer to Q2 :

Financing sources are dependent upon the periodicity for which the financing is required. Explained below the various sources for various requirements:

1. Long-term

• Share Capital
• Preferred stock
• Retained earnings
• Loans from financial institutions
• Venture capital funding
• Debentures/Bonds

2. Medium Term

• Preference shares
• Medium term loans from commercial banks, financial institutions
• Foreign Currency Bonds
• External Commercial Borrowings
• Public Deposits
• Fixed Deposits for medium term

3. Short Term

• Working Capital loans from commercial banks
• Fixed deposit for 1 year or less