Post a total of 3 substantive responses over 2 separate days for full participation. This includes your initial post and 2 replies to classmates or your faculty member.
Due Day 3
Respond to the following in a minimum of 175 words:
Explain the difference between a direct cost and an opportunity cost. Illustrate the difference of these costs by sharing one (1) out-of-pocket cost and one (1) opportunity cost for two decisions you made today. The decisions you choose to share can be anything, from your decision to drive to work versus riding a bike, or even the decision you made on where to have lunch.
Due Day 7
Post 2 substantial replies to classmates or your faculty member. Be constructive and professional. Remember that the replies should be at least 100 words. For more guidance see the Initial Announcement made on Day 1.
Discussion Topic: Cost of Capital
Cost of Capital: https://www.youtube.com/watch?v=B8JZhQofRTs
For this Discussion, imagine the following scenario:
You are the director of operations for your company, and your vice president wants to expand production by adding new and more expensive fabrication machines. You are directed to build a business case for implementing this program of capacity expansion. Assume the company’s weighted average cost of capital is 13%, the after-tax cost of debt is 7%, preferred stock is 10.5%, and common equity is 15%. As you work with your staff on the first cut of the business case, you surmise that this is a fairly risky project due to a recent slowing in product sales. As a matter of fact, when using the 13% weighted average cost of capital, you discover that the project is estimated to return about 10%, which is quite a bit less than the company’s weighted average cost of capital. An enterprising young analyst in your department, Harriet, suggests that the project is financed from retained earnings (50%) and bonds (50%). She reasons that using retained earnings does not cost the firm anything since it is cash you already have in the bank and the after-tax cost of debt is only 7%. That would lower your weighted average cost of capital to 3.5% and make your 10% projected return look great.
Based on the scenario above, post your reactions to the following questions and concerns:
What is your reaction to Harriet’s suggestion of using the cost of debt only? Is it a good idea or a bad idea? Why? Do you think capital projects should have their own unique cost of capital rates for budgeting purposes, as opposed to using the weighted average cost of capital (WACC) or the cost of equity capital as computed by CAPM? What about the relatively high risk inherent in this project? How can you factor into the analysis of the notion of risk so that all competing projects that have relatively lower or higher risks can be evaluated on a level playing field?
APA format, No Plagiarism 700