FIN370 Tutorial - 7051

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Question 1

 What are main elements in calculating the cost of capital? How does an increase in debt affect it? How do you identify an organization’s optimal cost of capital? (200 word)

 

Question 2

How could an organization calculate the long-term return on a project that experimented on letting an employee work from home verses in the office? (100 word)

 

Question 3

If Wal-Mart is receiving money for the products sold to consumers immediately - and not needing to pay manufacturers for at least 3 months - then Wal-Mart must be earning interest on the money it makes prior to paying for the products they are selling.  Right? (100 word)

 

Question 4

Your company purchases unsecured loans because the bookkeeping cost is low verses secured loans.  What does this mean?  The bookkeeping cost is equal to?  (100 word)

 

Question 5

Do you believe that there needs to be more government involvement in employee fairness when it comes to corporations? (100 word)

 

 


Question 6

Would the employee payout be less by outsourcing verses hiring and paying employee's under the corporation?   (100 word)

 


Question 7

What are some factors you would consider in making an investment if the NPV were 0 (or just above or below)? Would there be a reason to invest in a project if it doesn't add financial value to the firm? (100 word)

 

 

Solution Description

Question 1

 What are main elements in calculating the cost of capital? How does an increase in debt affect it? How do you identify an organization’s optimal cost of capital? (200 word)

Answer

The main elements of cost of capital are as follows:
a. Cost of Equity: this is the return required by the shareholders of the company. This consists of return in the form of capital growth (increase in the price of shares) or dividends
b. Cost of debt. This is the return required by the lenders on the loan they have extended to the company.
c. Cost of preference share capital (If any): The interest paid out on preference shares.
The cost of capital is calculated by weighing all of the sources of capital of the company. The weighting assigned to each source of finance in the capital structure should be the total of its market value.

As gearing increases, the cost of equity declines because debt is a cheaper source of finance (cost of debt is lower than cost of equity). However once a certain level of gearing is reached, the cost of equity rises since shareholders start expecting a premium for the risk taken due to high gearing. In order to identify the optimal cost of capital for an organization, you will need to include all factors such as the required costs, the marke