FINC615 Unit 3- Individual Project
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Hafsa Omar
Applied Managerial Finance:FINC615
Unit 3- Individual Project
Colorado Technical University
16/10/2023
1
Capital structure
Capital structure refers to the combination of different sources of funds that a company uses
to finance its operations and investments. It includes all the elements that make up a company's
financial structure, including equity, debt, and hybrid securities.
The two main components of capital structure are equity and debt. Equity consists of funds
raised through the sale of company shares, which represent ownership in the company.
Shareholders receive a portion of the company's profits in the form of dividends and have the
right to vote on important business decisions.
Debt, on the other hand, refers to funds borrowed by a company from lenders, such as banks
and bondholders, which must be repaid with interest. Debt financing can include short-term
loans, long-term bonds, and other types of loans.
Companies also have the option to use hybrid securities, which combine elements of both
debt and equity, in their capital structure. Examples of hybrid securities include convertible
bonds and preferred stock.
The way a company structures its capital can have a significant impact on its financial
stability, risk level, and overall cost of capital. Different industries and companies may have
varying optimal capital structures depending on their business operations, cash flow, and growth
opportunities. It is important for companies to maintain a balanced and well-managed capital
structure to support their growth and financial stability.
2
WAC
C
WACC = weight of equity*cost of equity + weight of debt*after tax cost of debt
Weight of equity = 60% or 0.6.
Cost of equity will be computed using the CAPM model.
ost of equity = risk free rate + beta*(return on market – risk free rate)
= 2% + 1.5*(11%-2%)
= 15.5%
After tax cost of debt = (1-35%)*8% = 5.20%
Thus WACC = 0.6*15.5% + 0.4*5.2%
= 11.38%
So WACC = 11.38%
Feasibility of the capital project
Calculating the weighted average cost of capital (WACC) is useful when determining the
feasibility of a capital project in the following ways:
1. It helps in evaluating the overall cost of capital: By including both equity and debt in the
calculation, WACC provides a comprehensive measure of the company's overall cost of capital.
3
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This can help in determining if the project is financially viable and if the company will be
able to generate enough return on investment to cover the cost of capital.
2. It accounts for the company's capital structure: WACC takes into consideration the
proportion of equity and debt in the company's capital structure. This is important as different
sources of capital have different costs and risks associated with them. A high WACC could
indicate that the company is heavily reliant on debt, which can be risky.
3. It helps in comparing projects: When evaluating multiple projects, WACC can be used to
compare the feasibility of each project. The project with a lower WACC is considered a better
investment opportunity as it has a lower cost of capital.
4. It provides a benchmark for setting hurdle rates: Companies often use WACC as a
benchmark for determining the minimum return on investment they require from a project. If the
estimated return on investment is lower than the WACC, then the project may not be considered
financially viable
5. It considers the after-tax cost of debt: WACC takes into account the after-tax cost of debt,
which is usually lower than the pre-tax cost of debt. This is because interest payments on debt
are tax-deductible, thus reducing the actual cost of debt to the company.
Overall, WACC is a useful tool in assessing the feasibility of a capital project as it provides a
comprehensive measure of the company's cost of capital and considers all sources of financing.
4
Recommendation
WACC is more appropriate to apply to project evaluation as it considers the specific
capital structure of the company and provides a comprehensive measure of the company's overall
cost of capital, which is essential in determining the financial viability of a capital project.
Additionally, WACC can be used as a benchmark for setting hurdle rates and comparing different
projects, making it a more versatile tool for project evaluation.
Define marginal cost of capital.
Marginal cost of capital is the additional cost that a company incurs for each additional
dollar of investment or financing. It is the change in the cost of capital resulting from an increase
in the level of investment or financing. This includes the cost of all sources of capital, such as
debt, equity, and retained earnings, and takes into account factors such as interest rates, taxes,
and risk.
The marginal cost of capital is important in determining the optimal capital structure for a
company and is used in investment decisions to evaluate the potential returns of a project or
investment. It can also be used to determine the price at which a company should issue new stock
or debt.
5
References:
Capital structure. (n.d.). CFA Institute. https://www.cfainstitute.org/en/membership/professional-
development/refresher-readings/capital-structure
Cost of Capital: Definition, Significance, & Formula. (n.d.). https://www.excedr.com/blog/cost-
of-capital#:~:text=The%20marginal%20cost%20of%20capital,new%20dollar%20of%20money
%20raised.
6
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Related Questions
A company's cost of capital refers to
Multiple Choice
O
O
the rate management expects to pay on all borrowed and equity funds.
the total cost of a capital project.
cost of printing and registering common stock shares.
the rate of return earned on total assets.
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9
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1. Capital allocation process
The capital allocation process involves the transfer of capital among different entities that include individuals, small businesses, banks, financial
intermediaries, companies, mutual funds, and other market participants. In a developed market economy, capital flows freely between entities that
want to supply capital to those who want it. This flow of capital can be classified in three ways. In the table below, identify the nature of capital
transfer given in the scenario with its appropriate classification:
Indirect Transfers
Indirect Transfers
Direct
Transfers
through
Investment Banks
through Financial
Intermediaries
Scenario
California Public Employees' Retirement System (CalPERS) manages pension
and health benefits of California public employees and retirees. CalPERS
collects money from its participants and creates a pool of assets. It manages
these assets by making investments across domestic and international
markets.
Based in Grass Valley,…
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Multiple Choice
operating cash flow.
net capital spending.
net working capital.
cash flow from assets.
cash flow to stockholders.
5
8
A
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What is meant by Capital Structure of a company? In this context, describe the varioussources of funding available to companies.
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Capital allocation process
The capital allocation process involves the transfer of capital among different entities that include individuals, small businesses, banks, financial intermediaries, companies, mutual funds, and other market participants. In a developed market economy, capital flows freely between entities that want to supply capital to those who want it. This flow of capital can be classified in three ways. In the table below, identify the nature of capital transfer given in the scenario with its appropriate classification:
Scenario
Direct Transfers
Indirect Transfers through Investment Banks
Indirect Transfers through Financial Intermediaries
Elliot invests $25,000 by purchasing 1,000 shares of an emerging markets mutual fund. This mutual fund invests in companies in Brazil, India, and China. He bought the mutual fund from the mutual fund company.
Steve’s grandfather loans him $30,000 to start a small coffee shop in the East Village in…
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Which of the following best defines the term "capital structure"?A) The way a company raises its capital through debt and equityB) The investment decisions made by a companyC) The amount of profit a company generatesD) The distribution of earnings to shareholdersneed help
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Which of the following best defines the term "capital structure"?A) The way a company raises its capital through debt and equityB) The investment decisions made by a companyC) The amount of profit a company generatesD) The distribution of earnings to shareholders
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10. As a legal entity, a corporation can perform the following functions EXCEPT:
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Compare and contrast the three forms of capital structure: all equity financing, debt and equity financing, and all debt financing. Which form of capital structure provides the greatest benefit to an organization’s shareholders? Why? Do you think that increased debt financing poses a greater risk to an organization? Why? Is there a correlation between risk and return for an organization’s shareholders?
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Based on the Republic Bank TT, an investment holding company, answer the following questions below using the following link below for help. Provide a detail explanation and examples to the answers.
https://www.republictt.com/pdfs/annual-reports/RFHL-Annual-Report-2022.pdf
Assess the company's working capital position by analyzing its current assets and liabilities using common methods and measures.
Evaluate the efficiency of the company's working capital management strategies, including inventory management, accounts receivable, and accounts payable.
Based on the assessment and evaluation above, provide ten recommendations for improving the company's working capital management practices.
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addresses the question of where money is raised to finance business
activities.
O Capital budgeting
O Capital structure
O working capital management
O Accounts receivable management
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