UNIT 3 IP FIN(2)

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Colorado Technical University *

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615

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Finance

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Jan 9, 2024

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Qiyoshi Trevillion December 3, 2023 Individual Project 3 Professor Perez

Capital Structure The particular mix of debt and equity which a company uses to finance its overall activities and expansion is referred to as the firm's capital structure. An organization’s capital structure is used to fund its expansion as well as the rest of its operations. In general, the capital structure of a company shall be described in terms of debt and equity ratio or debt to equity ratio. In order to understand WACC, it is necessary to understand the cost of capital. The cost of capital in the case of a company can simply be expressed as how much it must pay for its operations. Similarly, costs of capital are considered to be the least that a company can make on its own without going into bankruptcy or causing damage to investors. The cost of capital is the point at which a firm generates sufficient revenue for it to meet its current debt and equity commitments. WACC It is known as the weighted average cost of capital or WACC, which represents the amount that a company requires to finance its activities. The ratio of WACC and RRR is equal because a company's WACC constitutes the amount that creditors and shareholders demand in return for their investment. WACC is determined as follows for the example provided: Cost of capital = Cost of Debt (1-tax) + x Cost of Equity In the given scenario Debt 40% Equity 60% Tax Rate 35%

Cost of Debt 8% Beta of the Stock 1.5% Risk Free Rate = 2% Return on Market = 11% We would first compute return on equity, which is provided by Risk Free rate (RF) + [Return on Market (RM)-Risk free Rate (RF) x Beta] 2+ (11-2) x 1.5 = 12.5% Therefore, cost of capital would be equal to= 0.4x 8 % (1-0.35) + 0.6 x 12.5% WACC =15.18% Recommendation Any project should be evaluated for potential costs and risks before it is started, so knowing the precise figures is crucial to figuring out the investment. That being said, one metric that businesses use to assess the company's worth is the WACC. The company's value increases with a lower WACC. Given that the WACC in this instance is 15.88%, which is relatively low, the project has a high value and is therefore a wise investment. In the business world, figuring out the cost of capital is crucial for the reasons listed below: To increase the company's market value. The managers must take action to reduce expenses, including the cost of capital, in order to achieve this goal. Managers must understand the costs associated with various business financing options in order to make wise investment decisions. To determine the best and most suitable terms for the financing and revolving fund policies. Consequently, it is advised to use WACC

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when calculating the cost of capital because it takes into account the company’s capital structure and provides investors and management with a clearer picture when evaluating any project. Marginal Cost of Capital The marginal cost of capital, which needs to be increased in order to raise the last dollar of capital, usually increases in tandem with total capital. The marginal cost of capital is determined by taking the cost of the last dollar of capital raised and adding it. Raise capital generally results in an increase in the marginal cost of capital. The marginal cost of funds is an important cost that can be differentiated or added to when businesses have to make decisions in the future about their capital structure. Financial managers take into account the marginal cost of funds when selecting capital sources or financing options. The utilization of these financing strategies results in the least amount of an increase in overall funding costs.