Problem:
Write a substantive statement for each of the following:
Cost of Capital
Debt do lead to that of higher risk but in turn, if you are a corporate investor (or even a small private investor), at which point do you realize a company does indeed need to bring on more debt to say make a capital expenditure on more plant equipment. As for example, a colleague of mine's company, which is the pharmaceutical industry, is in need of bigger and much more expensive fermenters, which technically "grow" the samples for production for some of the medications sold on the marketplace. These fermenters are the same type of fermenter one sees at a winery but instead are used to ferment their medicines (I don't have all the technical jargon down, sorry). Long story short, these fermenters are the life and blood of the company and to grow, they need to continually upgrade their current fermenters thus they take on more debt. Risky? Absolutely. Necessary? Absolutely as well. It is indeed important to know the business and what exactly are their strategic plans. If this company did not buy and upgrade, taking on more debt, they would become obsolete within a year.
Cost of Capital
This is exactly what we've been discussing in class in determining the overall financial management of a business, company or organization. The risk, as you mentioned, is huge when you consider if, for example you work for a retail company, and your buyers "miss the mark" and order bright, bold colors for the next season (which is supposedly the coming trend) but yet, what if the customer doesn't relate to this new season's clothing and rejects the clothes full force. Your company has a lot at stake on ensuring the inventory is not only regulated tightly (too much or too little inventory, especially in clothing retail, is critical) but to ensure the inventory moves out at a profitable price, not the clearance rack. I would not be surprised if the CFO and the executive management team does look at ratios, cost of capital, etc. before they make big decisions on what to buy and not to buy. Do you know what type of data your company does look at before they commit to large purchases to stock up on inventory if you work for an organization that holds inventory?
Weighted Average Cost of Capital
It is smart for organizations to do a WACC calculation. It shows them what obligations need to be met financially. What if an organization cannot take on a drastic change in a rate that is involved with long term capital? Can the WACC be reevaluated? You mention that a WACC can be a time consuming process, but I think that it would be beneficial to any organization to do the calculations. They will then be able to see what risks are involved and if the rates of return are enough for the organization.
Initial Public Offering
As many of you have noticed, the current economic trends have not been toward forming an IPO or even doing a merger and/or acquisition. However, there still are deals being done no matter the economic climate. Not too long ago, there was a large merger going on between Live Nation and Ticketmaster, which combined the two powerhouses of concert venues, managing talent, and ticket distribution for special events. The Justice Department certainly did a test to determine if there is a monopoly at hand and the merger caused much distress amongst everyone from artists themselves to the general buying public (will tickets eventually become even more expensive?). Class, can you think of any other recent merger/acquisitions that have taken place and their overall impact?
Weighted Average Cost of Capital
What if an organization looked at the scope of a project and it did not turn out the way they had planned it to? Would the WACC still apply? I wonder if changes could be made to in order to compensate for the differences that came about? It is really important to make sure that the big picture is what an organization should expect. It would make things really complicated for the organization if they were wrong.