reply to the student responces in 150 words and provide 1 reference
If you were evaluating an investment opportunity, which technique would you use and why?
If the investment was an independent project, I would use the NPV technique as it is a direct representation of how much wealth the project will contribute to shareholders. IRR and MIRR can be unreliable if cash flows are non-normal, and payback method does not account for the change in time value of money over the years. The PI method is helpful, but seeing the value in dollars rather than a ratio is better for the overall evaluation.
4. Last year your company financed its investments by selling shares of common stock. This year the plan is to use debt. The after tax cost of debt is 5%, the cost of equity is 12% and the weighted average cost of capital is 9.5%. The first investment for this year is an expansion project. What cost of capital will you use and why?
I would used the WACC for the new years investment, as the weights that makeup the WACC are not intended to be used for any particular source of financing in a single year, but to develop the target capital structure. If the cost of debt was used for the years investment, this puts extreme limitations on the types of projects they can take on, not only this year, but the following year as well. The decision to take on a project depends on the projects ability to satisfy all investors, not just debtholders in that year.
5. The weighted average cost of capital can consist of debt, preferred stock and equity. Which of these sources is the most expensive and the least expensive and why?
The cost of new common equity is the most expensive due to floatation costs required to create new stock. Debt is the least expensive cost of capital due to the tax deductions on interest expenses, as well as the lower required rate of returns as debt holders have less risk in case of liquidation, therefore they can provide capital with lower expected return when compared to equity holders.
Brigham, E. & Ehrhardt, M. (2017). Corporate Finance: A Focused Approach, 6th Ed. Boston, MA: Cengage Learning.
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