Question

Capital Budget : Cost of Capital

Given the current COVID 19 situation, do you think that managers are currently more worried about the cost of capital or the future availability of capital?

What influences related to the present situation would influence the firms needed cash positions and use of debt or equity?

How is the current situation influencing the firm's capital budgeting decisions?

Answer 1

The current situation is so volatile that it has increased the risk factor of investment in financial markets. So raising funds from the financial market will be difficult as the investors are less willing to invest. Hence this has led to an increasing required rate of return for investors. But the bank lending rates are continuously going down so firms with good financials can raise debt from banks at a cheaper rate.

So managers are not that worried as the situation is getting better day by day and the volatility of the market is reducing.

The current situation enforced lockdown over worldwide which seized the operation of multiple companies hence the expected cash wasn't generated. This must-have affected the liquidity position of the company as there are some fixed costs associated and fixed financial obligations had to be repaid. So this must have influenced the cash position and use of debt or equity.

As the cost of equity has gone up hence the cost of capital has also increased substantially and the demand has fallen worldwide so the probability of generating future cash flow is also a challenge. At this point predicting the futurre cash flows and cost of capital is challenging for capital budgeting decisions.