Your firm’s geologists have discovered a small oil field in New York’s Westchester County. The field is forecasted to produce a cash flow of C1 = $2 million in the first year. You estimate that you could earn an expected return of r =12% from investing in stocks with a similar degree of risk to your oil field. Therefore, 12% is the opportunity cost of capital. What is the present value? The answer, of course, depends on what happens to the cash flows after the first year. Calculate present value for the following cases: The cash flows are forecasted to continue forever, with no expected growth or decline. The cash flows are forecasted to continue for 20 years only, with no expected growth or decline during that period. The cash flows are forecasted to continue forever, increasing by 3% per year because of inflation. The cash flows are forecasted to continue for 20 years only, increasing by 3% per year because of inflation
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.
Your firm’s geologists have discovered a small oil field in New York’s Westchester County. The field is
- The cash flows are forecasted to continue forever, with no expected growth or decline.
- The cash flows are forecasted to continue for 20 years only, with no expected growth or decline during that period.
- The cash flows are forecasted to continue forever, increasing by 3% per year because of inflation.
- The cash flows are forecasted to continue for 20 years only, increasing by 3% per year because of inflation
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