Question

In: Finance

Companies use the cost of capital formula/steps to make strategic decisions. Often, they may have a...

Companies use the cost of capital formula/steps to make strategic decisions. Often, they may have a simple structure either common stocks or long-term debt. Why do think managers still use the complexity of the cost of capital to determine their long-term final position? How would managers determine the percentages of each source of capital to achieve the optimal weighted average cost of capital?

Solutions

Expert Solution

Cost of capital can be defined as the opportunity cost incurred with respect to a particular investment decision. It is calculated in % terms and is referred as the rate of return that could have been earned by putting the same money into a different investment with same amount of risk involved.

Companies use the cost of capital formula/steps to make strategic decisions The managers still use the complexity of the cost of capital to determine their long-term final position as it is an accurate and more reliable measure of evaluating the financial position of the company. The cost of capital aims at evaluating all investment opportunities made by the business. It also helps in deciding the budget constraints for the company.

In order to to achieve the optimal weighted average cost of capital different capital structures are examined and evaluated and the proporation with regard to avalability which gives the minimum cost of capital is adopted. As minimum cost of capital ensures maximum profits for the entity.


Related Solutions

Explain the concept of cost of capital. How may cost of capital affect long-term financial decisions?...
Explain the concept of cost of capital. How may cost of capital affect long-term financial decisions? Would a company prefer to have a high or low cost of capital? Why? What was the effect of cost of capital on long-term financial decisions for your company?
As companies grow and expand, they often prefer to make use of mergers and acquisitions of...
As companies grow and expand, they often prefer to make use of mergers and acquisitions of existing companies instead of growing their businesses via organic growth. In this context they may also desire to reorganize their ownership structure or divest themselves of certain business activities or assets. Please explain why companies may decide to use M&A and the potential benefits of such actions. Then provide an explanation of the alternative types of reorganizations and how these transactions work to accomplish...
How do you or other people use the present-value formula to make decisions?
How do you or other people use the present-value formula to make decisions?
As part of their job responsibilities, engineers often have to make decisions related to the financial...
As part of their job responsibilities, engineers often have to make decisions related to the financial well-being of their organization. This includes the process of downsizing: reducing their staff and subcontracting the work/jobs. Some of the reasons for downsizing include: To reduce the cost of production/operations by shifting work to lower-cost wage regions (domestically or internationally). To reduce the cost of production/operations by introducing advanced technologies (e.g. automation) that require fewer employees To gain market share in other regions by...
Discuss how a company can make strategic changes that will change their cost of capital. These...
Discuss how a company can make strategic changes that will change their cost of capital. These changes can be positive or negative and increase or decrease the cost of capital. Also discuss what variable(s) the company has no control over to effect change in the cost of capital and why this is the case.
the use of cost information in short- a term long- term, and strategic decisions making, planning...
the use of cost information in short- a term long- term, and strategic decisions making, planning and control in contemporary organizations
Ethics and Professional Judgment in Accounting. Accounting professionals will use judgement often to make ethical decisions....
Ethics and Professional Judgment in Accounting. Accounting professionals will use judgement often to make ethical decisions. Integrity, objectivity and professional judgement are the core values of GAAP. Professional judgement are based on the information gathered and probing question to make a audit judgment. Professional judgment is what makes an accountant a professional and it underlies the fundamental obligation to protect the public interest. The profession’s codes of ethics call for independent judgments and to not subordinate professional judgment to a...
discuss how you think companies make capital budgeting decisions and how the process would be different...
discuss how you think companies make capital budgeting decisions and how the process would be different during special times, such as pandemic?
Different companies may have or may choose to have different cost structures for the same product....
Different companies may have or may choose to have different cost structures for the same product. Many companies try to lower total cost regardless of output but, if it were so easy, then it would already have been done. So, consider a change in cost structure which combines a 10 percent increase in fixed cost and a sufficient decrease in marginal cost which does not change BE. a) How large is the required decrease in marginal cost? b) Over what...
Managers often make the mistake of basing decisions on the amount of time and effort that...
Managers often make the mistake of basing decisions on the amount of time and effort that has gone into a project. In many cases, they are reluctant to cancel a project out of fear of being viewed as having wasted resources, or due to an emotional attachment to their prior choices. Why is this so? Should managers consider past investments when making decisions? Is the textbook's recommendations regarding sunk costs realistic in a modern corporate environment? Offer examples to support...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT