The rates of WACC
- In the given situation, the initial WACC is 13%, while the new WACC is just 3.5%. At a 10% projected rate of return, the company can opt for the suggestion as the WACC proposed by Harriet is just 3.5%, much less than the risk-free rate. Using 50% of capital from debt and the remaining from retained earning appears to be a great option since there will be lower cash outflow. Cash liquidity and the tax benefits of debt are crucial for business.
In the case of capital projects, there is not a predefined cost of capital. Capital cost considers what the sources of funds are and where and how they can be obtained, be it bonds, equity, or retained earnings. The project comes with high inherent risk as the project products are slowing down the sales. In the case of reduced sales, breaking even with the debt will be impossible.
- The choice of going for the debt cost only will not be a great option as the organization must take the retained earnings into consideration. It brings the opportunity to earn some interest from the banks and thus can be a better option for this project. The primary objective of the project is to control the overall costs associated with it. Under such considerations, financing the project using retained cash and debt can be significant.
Don't use plagiarised sources.Get your custom essay just from $11/page
Every project comes with a set of associated risks that can or cannot be compared with the risks spread across the firm. Using the firm-wide statistics for WACC is not a good option. Adjusting the rates of discount for a project is crucial as per the risk level. In case the risks are higher, using higher rates of discount is the option and vice versa. Once the discount rates are obtained, it can be used for the NPV calculation of the projects.
- The suggestion presented by Harriet is not a great option as using the debt only can affect the confidence of the investors. Increased borrowing can bring uncertainty for cash flow in the future. In addition, the suppliers can also lose confidence in financial status, thus causing supply disruption. Debt can help to cut down tax. Also, it can trigger a negative flow of cash. In case of a shortage of finance, the organizations disrupt their processes.
The rates of WACC can be used as the capital cost. It is because the capital cost and the debt of the project are weighed using the concept. Increased project risk hints towards increased debt and decreased equity. It may be helpful in tax affairs but is not dependable due to the negative cash flow and the uncertainties it is associated with. The cost of capital concept of the NVP analysis can be used for the evaluation of the projects’ risk notions.