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Walden University Week 5 Managerial Finance Discussion

Walden University Week 5 Managerial Finance Discussion

Question Description

I’m trying to learn for my Management class and I’m stuck. Can you help?

DISCUSSION 1

For this Discussion, imagine the following scenario:

You are the director of operations for your company, and your vice president wants to expand production by adding new and more expensive fabrication machines. You are directed to build a business case for implementing this program of capacity expansion. Assume the company’s weighted average cost of capital is 13%, the after-tax cost of debt is 7%, preferred stock is 10.5%, and common equity is 15%. As you work with your staff on the first cut of the business case, you surmise that this is a fairly risky project due to a recent slowing in product sales. As a matter of fact, when using the 13% weighted average cost of capital, you discover that the project is estimated to return about 10%, which is quite a bit less than the company’s weighted average cost of capital. An enterprising young analyst in your department, Harriet, suggests that the project be financed from retained earnings (50%) and bonds (50%). She reasons that using retained earnings does not cost the firm anything, since it is cash you already have in the bank and the after-tax cost of debt is only 7%. That would lower your weighted average cost of capital to 3.5% and make your 10% projected return look great.

Prepare your reactions to the following questions and concerns:

What is your reaction to Harriet’s suggestion of using the cost of debt only? Is it a good idea or a bad idea? Why? Do you think capital projects should have their own unique cost of capital rates for budgeting purposes, as opposed to using the weighted average cost of capital (WACC) or the cost of equity capital as computed by CAPM? What about the relatively high risk inherent in this project? How can you factor into the analysis the notion of risk so that all competing projects that have relatively lower or higher risks can be evaluated on a level playing field?

Refereces

Brigham, E. F. , & Houston, J. F. (2019). Fundamentals of financial management (15th ed.). Boston, MA: Cengage Learning.

Chapter 10, “The Cost of Capital” (pp. 356-384)

DISCUSSION 2

To prepare for this Discussion: Review the evaluation methods utilized by organizations for decision making. Consider your professional experience, knowledge gained from this week’s resources, and/or additional research.

Prepare the following:

~ Evaluate the advantages and disadvantages of the various decision-making tools listed (e.g., regular payback, discounted payback, net present value (NPV), internal rate of return (IRR), and modified internal rate of return).

~ Describe a project scenario in which you would recommend one method, or a combination of methods, as being more effective than others. Draw from your professional experience and/or additional research, and provide a rationale for your recommendation.

References

Brigham, E. F. , & Houston, J. F. (2019). Fundamentals of financial management (15th ed.). Boston, MA: Cengage Learning.

Chapter 8, “Risk and Rates of Return” (Review Section 8-3, “Risk in a Portfolio Context: CAPM” on pp. 283-285)

Chapter 11, “The Basics of Capital Budgeting” (pp. 385-416)


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