Finance Companies A and B are each considering an unanticipated new investment opportunity that will marginally increase the value of the company and will also increase the company’s level of diversication. Company A is unlevered, and company B has a capital structure of 50% debt. Assume that the shareholders control the company, which one of the following statements is correct. a) Since NPV of the investment is positive both company A and B will accept the project. b) Since the project only marginally increase company values but decreases return variance of the company’s assets both companies will reject the project. c) It is more obvious that Company B invests since for levered company the diversication benefits are more important. d) None of the given alternative.
Cost of Capital
Shareholders and investors who invest into the capital of the firm desire to have a suitable return on their investment funding. The cost of capital reflects what shareholders expect. It is a discount rate for converting expected cash flow into present cash flow.
Capital Structure
Capital structure is the combination of debt and equity employed by an organization in order to take care of its operations. It is an important concept in corporate finance and is expressed in the form of a debt-equity ratio.
Weighted Average Cost of Capital
The Weighted Average Cost of Capital is a tool used for calculating the cost of capital for a firm wherein proportional weightage is assigned to each category of capital. It can also be defined as the average amount that a firm needs to pay its stakeholders and for its security to finance the assets. The most commonly used sources of capital include common stocks, bonds, long-term debts, etc. The increase in weighted average cost of capital is an indicator of a decrease in the valuation of a firm and an increase in its risk.
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