Question:
After considering expanding your line of apparel and gathering information on the increase in sales for your division and the investment needed in new manufacturing equipment, without having to hire additional manufacturing personnel, you arrange a meeting with the CFO. During the meeting Don listened to your proposal, reviewed your information, but questioned your use of a 6% cost of capital. He indicated to you that the head of treasury could raise debt at 7% in today's market. Taking into consideration how a company's cost of capital is calculated, and how market rates and the company's perceived market risk impacts a firm's cost of capital, provide your viewpoint on whether 6% is reflective of On Your Mark's current cost of capital. Include in your assessment the following:
What does a company's cost of capital represent and how is it calculated?
How do market rates and the company's perceived market risk influence its cost of capital, and how does the company's debt to equity mix impact this cost of capital?
What is market risk and how is it measured?
Don mentioned using standard deviation and the coefficient of variation to measure risk. What does that mean?