Question

1. WACC What role does the cost of capital play in the overall financial decision making of the firm’s top managers?

2. DEBT VS EQUITY Why do you think debt offerings are more common than equity offerings and typically much larger as well?

Answer 1

1. Cost of capital is the capital helps to limit costs by analysing projects and there by helps to maximize investment. Helps to make better decisions there by maximum profit. It helps in making decisions regarding how they could allocate their money effectively.It evaluates all the business opportunities. It converts future cash flows of investment to present value using discount factor. By calculating cost of capital we could decide whether to accept or reject the project. A investment must cover its cost of capital and then only it gets starts earning.Helps to evaluate progress of existing projects. There are two kinds of cost associated with cost of capital they are Explicit costs and Implicit costs. Implicit costs are the opportunity cost or the cost of next best alternative investment sacrificed for selecting current investment Explicit costs are payable back to investors in the form of dividend or stock price

Costof capital comprises of Cost of equity,Cost of debt

WACC stands for Weighted average cost of capital. It is a combined cost of capital of various resources. These resources includes common stock,preferred shares and debt. A weightage is given to each one it gets multiplied by cost and they are added together. It helps in making investment decisions.

2. Debt is a borrowed money. It is to ne repaid with interest. Equity is raising money by providing stock in the company and make them shareholders. Debts are the most cheapest source of income. Cost of equity is infinite but the cost of debt is finite.Equity is more riskier than debt. Equity is made up of ownership whereas debt is made up of obligation which ends when debt get repayed. Use of debt makes tax savings and also helps to make profit. Debts are easy to raise. Firm have to consult equity shareholders before making decisions but not needed in case of debt. Interest on debt is tax deductible, dividends are not tax deductible.