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.
FIN 3004 Business Finance
Homework
Bell Manufacturing Inc. is considering the replacement of one of its old drill presses. Three alternative replacement presses are under consideration. The relevant cash flows associated with each are shown in the following table. The firm’s cost of capital is 15%.
|
|
Machine A |
Machine B |
Machine C |
|
Initial Investment
|
85,000 $ |
60,000 $ |
130,000 $ |
|
Year |
|
||
|
1 |
18,000 $ |
12,000 $ |
50,000 $ |
|
2 |
18,000 |
14,000 |
30,000 |
|
3 |
18,000 |
16,000 |
20,000 |
|
4 |
18,000 |
18,000 |
20,000 |
|
5 |
18,000 |
20,000 |
20,000 |
|
6 |
18,000 |
25,000 |
30,000 |
|
7 |
18,000 |
----- |
40,000 |
|
8 |
18,000 |
----- |
50,000 |
- Calculate the
net present value (NPV) of each press. - Using NPV, evaluate the acceptability of each press.
- Rank the presses from best to worst using NPV.
- Calculate the profitability index (PI) for each press.
- Rank the presses from best to worst using PI.
Step by step
Solved in 2 steps
