Please read the below discussion post and provide the 2 responses in 50 to 75 words
1 .The calculation of a company’s capital cost including several factors proportionately being weighted gives the weighted average cost of the capital. It has several factors contributing such as bonds, preferred stocks, common stocks, and other long-term debts of the company. A specific formula issued for the calculation of WACC.
WACC = equity percentage of financing * cost of equity + debt percentage of financing * cost of debt * (1-corporate tax rate)
Weighted the average cost of capital has a significant role to play in the decision making of the firm. The security analyst of the frim uses WACC to understand the investment and make a decision as to which investment will be beneficial for the firm. The firm when acts at the investors then the WACC serves as providing information about minimum return rate from the investment and thus the decision is based on that. The profit margin of such investment if is indicative to be high as per WACC calculation then the firm proceeds with that investment and vice versa (Zafiris, 2016).
2 .Cost of debt is the debt that the company pays for the particular stock as per the market value of the debt. It is a straightforward term that does not require complex understanding or calculation. The corporate tax is the amount that is deducted from the debt being paid by the company and is thus considered to be beneficial for the company and gives the net value of debt by removing tax deduction from the overall debt value (Khomar, 2019).
Cost of equity requires a thorough understanding of the stock and debt, and it is determined by calculating the relative cost of an investment when the company is not entitled to pay any debt for other stock which indicated that the company will only raise profit money by investing in one stock without having to pay any other debt. WACC takes into account both the mentioned, cost of debt as well as the cost of equity (Khomar, 2019).
A company’s weighted average cost of capital (WACC) is the average interest rate it must pay to finance its assets, growth, and working capital. The WACC is also the minimum average rate of return it must earn on its current assets to satisfy its shareholders, investors, or creditors. The result of the WACC calculation is only an estimate. Multiple values in parts of the equation should be substituted to forecast investment possibilities. The WACC is based on a company’s capital structure how it is financed and is comprised of both debt financing and equity financing. The cost of capital is how much a firm pays to finance its operations either debt or equity. Included in the cost of capital are common stock, preferred stock, and debt. The cost of capital is how much interest a company pays on each form of financing ( Frank, M. Z., & Shen, T. (2016)).
A company can raise funds in limited ways. It can sell bonds, borrow money, and leverage equity financing. Cost of capital is considered as the financing costs a company must pay when borrowing money, using equity financing, or selling bonds to fund a big project or investment. In each case, the cost of capital is expressed as an annual interest rate. When weighing a big investment, like funding a new manufacturing plant, the cost of capital represents the return rate the company could garner if it invested cash in an alternative investment, with the same risk applied. That’s why economists equate the cost of capital with the opportunity cost of a company using financial capital for a significant project or investment. Some small business firms only use debt financing for their operations. Other small startups only use equity financing, particularly if they are funded by equity investors such as venture capitalists.
The cost of debt does not represent just one loan or bond. The cost of debt theoretically shows the current market rate the company is paying on its debt. Though, the real cost of debt is not necessarily equal to the total interest paid, because the company is able to benefit from tax deductions on interest paid. The real cost of debt is equal to interest paid less any tax deductions on interest paid. The dividends paid on preferred stock are considered a cost of debt, even though preferred shares are technically a type of equity ownership ( Boles, K. E. (1986)).
The cost of equity is complicated to estimate. Shareholders do not explicitly demand a certain rate on their capital in the way bondholders or other creditors do common stock does not have a required interest rate. The most common method used to calculate the cost of equity is known as the capital asset pricing model, or CAPM. This involves finding the premium on company stock required to make it more attractive than a risk-free investment, such as U.S. Treasury’s, after accounting for market risk and unsystematic risk.
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