Week 5 Discussion: Cost of Capital
RESPONSE FOR THE DISCUSSION:

In your response to your classmates, consider comparing cash generation techniques at your company versus his or her company. Draw distinctions based on the industry and tell your colleagues why those distinctions are necessary for the management of cash flow. Below are additional suggestions on how to respond to your classmates’ discussions:

· Ask a probing question, substantiated with additional background information, evidence or research.

· Share an insight from having read your colleagues’ postings, synthesizing the information to provide new perspectives.

· Offer and support an alternative perspective using readings from the classroom or from your own research.

· Validate an idea with your own experience and additional research.

· Make a suggestion based on additional evidence drawn from readings or after synthesizing multiple postings.

· Expand on your colleagues’ postings by providing additional insights or contrasting perspectives based on readings and evidence.

Discussion_

Author: by Sree Latha Lakkaraju

A review of financial concepts and their impact on organizational decision-making

The given brief about the use of the cost of debt reveals the opinions and suggestions of Harriet. It should be noted that organizations should stay away from funding processes with the sole usage of the cost of debt. When an organization relies solely on the cost of debt, it is likely to increase the number of liabilities related to debts. The organization is liable to return the borrowed amount along with interest. Therefore, these issues tend to emerge when employing the use of the cost of debt. Again, no organization would want to call additional risks and uncertainties into their business (Sengupta, 1998). Moreover, lenders are likely to be suspicious of the borrowers or the company’s financial position. The lenders usually doubt the abilities of the borrower to pay the amount with interest. This creates additional pressure for the organization. Again, business environments are vulnerable to financial risks and disputes. Any form of the legal issue might damage the reputation of the business. Hence, it will be less cost-effective for organizations to follow Harriet’s suggestions.

Exploring the concept of cost of capital rates

In the case of major capital-intensive projects, a huge cost of capital is required. After funding a project, organizations expect huge returns. It is vital to analyze the rate of capital costs related to huge projects because organizations want to ascertain greater returns as well. In this instance, the concept of WACC comes into the picture. In the case of WACC, both debt and equity weighted average are considered for the calculation (Solomon, 1955). Additionally, it is required to use both WACC and CAPM for ensuring the return of project outcomes. Capital resources are required for creating a balance as well. Funding can be acquired in two ways- equity or debt. However, there is a third way to acquire funding. It can be acquired by combining both equity and debt. When both the strategies are combined, the weighted average can be calculated with the help of WACC. Here, WACC will act as the cost of capital. This idea is supported by the CAPM model as well. The strategy can be utilized by organizations for determining the return rate for the company investors.

An overview of risks associated with capital projects

It should be noted that capital projects are vulnerable to various types of geopolitical, regulatory, financial, and economic, and social risks. While taking the current organization into consideration, it can be ascertained that the organization is vulnerable to various types of market forces and fluctuations. Uncertainty in the markets leads to a decrease in the overall sales volume of companies. Consequently, a decrease in sales volume has a negative impact on capital projects as well. The returns that could have been derived from the capital projects reduce as well. In a fluctuating market condition, it will be impossible to generate suitable returns after investments. Risks are always associated with capital projects. Therefore, it would be necessary to maintain a risk portfolio. Capital project documentation can be done using risk portfolios (Esty, 2004). Individual risks are subjected to separate kinds of risks. Firstly, the way to deal with risks is the evaluation of various phases of risks. High-risk areas need to be prioritized and low-risk areas can be marked for later considerations. Furthermore, methods such as quantitative risk assessment and qualitative risk assessment can be done. Both types of assessments can bear different types of useful analysis. For instance, the quantitative assessment helps in the evaluation of uncertainties while qualitative risk analysis can be used for assessing the probability and frequency of the occurrence of risks.

References

Esty, B. C. (2004). Why study large projects? An introduction to research on project finance. European Financial Management, 10(2), 213-224.

Sengupta, P. (1998). Corporate disclosure quality and the cost of debt. Accounting review, 459-474.

Solomon, E. (1955). Measuring a Company’s Cost of Capital. The Journal of Business, 28(4), 240-252.