Business Finance 2 Dersi 2. Ünite Sorularla Öğrenelim
Cost Of Capital
- Özet
- Sorularla Öğrenelim
What is the most important factor of production?
Every business requires capital to invest. Therefore, capital is the most important factor of production and the cost of capital is the most significant determinant in investment decisions.
The cost of capital is the average cost of the capital mix. What does this 'average cost of the capital mix' refer to?
Average cost of the capital mix refers to the mix of debt and equity in financing decisions.
The component cost is the required return of the capital component which varies with investors’ risk. In case of debt financing, what does creditors’ required return mainly changes with?
The component cost is the required return of the capital component which varies with investors’ risk. In case of debt financing, creditors’ required return mainly changes with the lending horizon and the credit-worthiness of the borrower.
How do managers evaluate capital budgeting decisions?
Managers evaluate capital budgeting decisions according to the firm’s cost of capital. The return from the capital investments should be more than the cost of the capital utilized in financing them. Hence, cost of capital is a major criterion in capital budgeting decisions.
The component cost is the required return of the capital component which varies with investors’ risk. In case of equity financing, what is stockholders’ required return altered by?
In case of equity financing, stockholders’ required return is altered by the riskiness of the investments undertaken by the firm.
A company may raise debt financing either through _________ or ____________.
A company may raise debt financing either through bank loans or bond issues.
A company may raise debt financing either through bank loans or bond issues. In both types of borrowing the interest rate may be either fixed or floating. If the rate is floating, then what is the purpose of the utilization of an index?
A company may raise debt financing either through bank loans or bond issues. In both types of borrowing the interest rate may be either fixed or floating. If the rate is floating, then an index is used to determine the interest payments for each period.
What does LIBOR stand for?
LIBOR stands for London Interbank Offered Rate.
In bond issues if the interest rate is floating and not fixed, what is the 'bond' called?
In bond issues if the interest rate is floating and not fixed, then it is called as an indexed bond. The index can be any economic indicator but mostly it is a price index, such as the inflation rate, the oil price or the gold price index.
Apart from indexed bonds, companies may issue convertible or callable bonds. What right do convertible bonds give to the bondholders?
Apart from indexed bonds, companies may issue convertible or callable bonds. Convertible bonds give the bondholders the right of converting the bonds into common stocks of the company at a predetermined conversion rate.
How should working capital requirements and fixed asset investments be financed?
Working capital requirements should be financed with short-term funds through commercial paper issues, whereas fixed asset investments should be made with long-term borrowings such as corporate bond issues.
What is the cost of equity?
The cost of equity is the return a company requires to decide if an investment meets capital return requirements.
Why does a firm use cost of equity?
A firm uses cost of equity to assess the relative attractiveness of investments, including both internal projects and external acquisition opportunities.
How is common equity financing raised?
Common equity financing is raised either by issuing new shares or by retaining the net income earned. The former is external financing while the latter is an internal source.
What does CAPM (Capital Asset Pricing Model) estimate?
The CAPM estimates the required return of a stock investment in relation to its systematic risk which cannot be diversified away in a portfolio context.
In Capital Asset Pricing Model, what is the starting point in calculating the required return?
The starting point in calculating the required return is the estimation of the risk-free rate (krf). In real life, there is no totally riskless investment. However in any economy, the securities issued by the Treasury are free of default risk.
In Capital Asset Pricing Model, what are the second and third and final points in calculating the required return?
Secondly, in CAPM applications the estimation of the market return, hence the market risk premium (MRP) which is the expected market return minus the risk-free rate is essential. Thirdly, the beta of the stock in question is determined. As a final step, after the estimation of all the parameters in the CAPM equation, the required return on the stock is computed, which is the cost of the common equity.
What is 'Bond-Yield-Plus-Risk-Premium Approach' based upon?
The bond-yield-plus-risk-premium approach provides a practical but highly subjective solution to the estimation of the cost of equity. The approach is based upon adding up a risk premium over the firm’s bond yield.
What should the WACC (Weighted Average Cost of Capital) estimation be based on?
The WACC estimation should be based on the market values of the capital components since investors require to be compensated on the full amount of their investments at stake which is the current market value of the investment.
What are the steps for estimating the marginal cost of capital?
In order to estimate the marginal cost of capital, firstly the amount of the additional new capital that raises the cost of capital is to be determined. Then the weighted average cost of capital is calculated at that amount of new capital raised.