In: Finance
1. You are considering an increased capital expenditure for PP&E for next year. You are, however, concerned that the expenditure would hurt earnings per share over the next few years. Also, this might not be in your shareholders’ best interest. Is your concern justified? What additional information do you need to respond properly?
- I understand this has to do with depreciation, EPS, CAPEX, NPV, CF, and WACC but not quite sure how they all relate to one another. Explain this in the context of the problem please.
2. If debt is used to finance a new investment, shareholders will be worse off than if retained earnings were used to finance the new investment. Discuss the validity of the statement and state any assumptions deemed relevant.
-Please explain how WACC and CF's are involved in this scenario. Also, explain the company's strategy, growth or as a going concern.
The weighted average cost of capital
(WACC) is the rate that a company is expected to pay on average to
all its security holders to finance its assets. The WACC is
commonly referred to as the firm's cost of capital. Importantly, it
is dictated by the external market and not by management. The WACC
represents the minimum return that a company must earn on an
existing asset base to satisfy its creditors, owners, and other
providers of capital, or they will invest elsewhere.
Earnings per share (EPS) is the monetary value of earnings per
outstanding share of common stock for a company.
In the United States, the Financial
Accounting Standards Board (FASB) requires EPS information for the
four major categories of the income statement: continuing
operations, discontinued operations, extraordinary items, and net
income.
Capital expenditure or capital expense (capex or CAPEX) is the
money an organization or corporate entity spends to buy, maintain,
or improve its fixed assets, such as buildings, vehicles,
equipment, or land. It is considered a capital expenditure when the
asset is newly purchased or when money is used towards extending
the useful life of an existing asset, such as repairing the
roof.
Capital expenditures contrast with
operating expenses (opex), which are ongoing expenses that are
inherent to the operation of the asset. Opex includes items like
electricity or cleaning. The difference between opex and capex may
not be immediately obvious for some expenses; for instance,
repaving the parking lot may be thought of inherent to the
operation of a shopping mall. The dividing line for items like
these is that the expense is considered capex if the financial
benefit of the expenditure extends beyond the current fiscal
year.
Net present value (NPV) is the difference between the present value
of cash inflows and the present value of cash outflows over a
period of time. NPV is used in capital budgeting and investment
planning to analyze the profitability of a projected investment or
project.
a cash flow in its narrow sense is a payment (in a currency),
especially from one central bank account to another; the term 'cash
flow' is mostly used to describe payments that are expected to
happen in the future, are thus uncertain and therefore need to be
forecast with cash flows;
a cash flow is determined by its time t, nominal amount N, currency
CCY and account A; symbolically CF = CF(t,N,CCY,A).
it is however popular to use cash flow in a less specified sense
describing (symbolic) payments into or out of a business, project,
or financial product.
Cash flows are narrowly interconnected with the concepts of value,
interest rate and liquidity. A cash flow that shall happen on a
future day tN can be transformed into a cash flow of the same value
in t0.