I’m working on a business discussion question and need support to help me understand better.
Here is the discussion and I have to respond to each student 100 words
This Unit’s Discussion Topics
Choose one of the following to respond to:
- Discuss the three most common sources of capital including the advantage and drawbacks to each.
- Discuss the payback method for evaluating projects including the components and calculations involved as well as how to evaluate the output. What are the benefits and drawbacks of this method?
- Discuss the net present value method for evaluating projects including the components and calculations involved as well as how to evaluate the output. What are the benefits and drawbacks of this method?
- Discuss the internal rate of return method for evaluating projects including the components and calculations involved as well as how to evaluate the output. What are the benefits and drawbacks of this method?
- Discuss the weighted average cost of capital including how it is calculated and what it represents.
Discuss the three most common sources of capital including the advantage and drawbacks to each.
The three most common sources of capital are debt financing, equity financing, and preferred stock.
Debt financing is money borrowed and paid back with interest to a lender. A couple of advantages of debt financing are the lender has no control over your business, and once you pay the loan back, you no longer have a relationship with the lender. The drawback is if your business comes to hardship, the debt still has to be paid back regularly, and if you cant pay it back, it just keeps adding up plus fees.
Equity financing is selling a portion of the businesss equity in return for capital. An advantage of equity financing is there is no repaying the money acquired back, so if the business is having a hardship, there is no additional burden. The drawback is you now have an investor with a percentage of your company that you have to share your profits with and discuss new decisions that affect the company.
Preferred stock is issued by companies wanting to raise capital. An advantage is they collect dividend payments before common stock shareholders receive such income, and a drawback, they do not enjoy the voting rights that common shareholders typically do. (Boyte-White, 2020).
Boyte-White, C. (2020, August 28). Preference shares: Advantages and disadvantages. Retrieved May 01, 2021, from https://www.investopedia.com/ask/answers/040915/wh…
Maverick, J. (2021, April 27). Equity financing vs. debt financing: What’s the difference? Retrieved May 01, 2021, from https://www.investopedia.com/ask/answers/042215/wh…
Discuss the weighted average cost of capital including how it is calculated and what it represents.
According to our reading and lecture. The Weighted Average Cost of Capital (WACC) is defined as the computed cost of capital, or finances available to a firm, determined by multiplying the cost of each item in the optimal capital structure by its weighted representation in the overall capital structure and summing up the results. The formula to calculate WACC is:
WACC = Cost of Equity * Percent of Capital that is Equity + Cost of Debt * Percent of Capital that is Debt * ( 1- Tax Rate) + Preferred Stock * Percent of Preferred Stock
It can also be calculated without Preferred Stock by using the following formula:
WACC = (E/V * Re) + ((D/V * Rd) * (1 T)) where:
E = Market Value of firms Equity or Market Cap
D = Market Value of firms Debt
V = Total Value of Capital (Equity plus Debt
E/V = Percent of Capital that is Equity
Re = Cost of Equity
D/V = Percent of Capital that is Debt
Rd = Cost of Debt (Yield to maturity on existing Debt)
T = Tax rate
For example, Walmart is trying to determine its WACC and has the following:
E= $276.7 billion D= $50 billion V= $326.7 billion
E/V = 85% Re = 4.3% D/V = 15% Rd = 4,7%
T = 30%
We can calculate this as:
WACC = (85% * 4.3%) + ((15% * 4.7% )* (1 – 30%))
WACC = 4.2%
According to Investopedia, WACC is frequently used by securities analysts to assess the value of investments and when determining which ones to pursue. It is essential in order to perform economic value-added (EVA) calculations and may also be used as a hurdle rate against which companies and investors can gauge return on invested capital (ROIC) performance. In basic terms, WACC is the minimum acceptable rate of return at which a company yields returns for its investors.
Block, S., Hirt, G., & Danielsen, B. (2016). Foundations of Financial Management. McGraw-Hill Education Publishing.
Corporate Finance Institute. (2021). WACC Formula, Definition and Uses: Guide to Cost of Capital. Retrieved from: https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-wacc-formula/
Hargrave, M. (2021). How to Calculate the Weighted Average Cost of Capital – WACC. Retrieved from: https://www.investopedia.com/terms/w/wacc.asp#:~:text=The%20formula%20is%20risk-free,generally%20estimated%20to%20be%207%25