Unit 1 Discussion/Student Response

Initial Critical Exchange Forum Comment

Student initial critical exchange forum comments are due weekly by Wednesday. Initial response comments should approximate 300-350 words, and contain at least two outside scholarly reference sources.

Note that a total of 3 logins and 3 exchange forum posts are required on 3 separate days.

Students are required to research their selected forum topic, and then compile a 300-350-word response to the forum topic no later than Day 3 (Wednesday) of the week. A choice of critical exchange forum topics is assigned weekly. Students are expected to select an aspect of interest from the list of topics offered; students may also choose to combine topics. APA format is required. Submit your forum topic using the critical exchange forum assignment link.

Critical exchange forum topic response contributions will be critically graded on the thought quality of the response, work effort, research, and analysis.

Select one of the following forum topics to research and write about.

  Forum Topics(Select one)

Subjects: Capital Structure in a Perfect Market; Debt & Taxes

• Financing a firm with equity and/or debt
• Modigliani & Miller: Leverage, risk & the cost of capital
• Cost of capital
• The interest tax deduction
• The interest tax shield
• Optimal capital structure: the tradeoff theory

Student Response

Critical Exchange Forum Responses

In addition to students)nitial critical exchange forum comments, students are also expected to actively participate in the in the forum discussion. Active participation requires a minimum of two forum logins on two separate days. Thus, a minimum of three logins on three separate days is required to earn full credit. Forum response participation posts require a minimum of 150-250 words to earn full participation points.

Guidelines for student forum discussion/participation:

• Select a fellow student’s response and compare and contrast your thoughts with theirs;
• Advance the conversation; provide a real-world application and experiential examples;
• Conceptually discuss your key [most significant] learning insight or take-away from the selected forum topic comments.
• Responses should be a minimum of 150-250 words, supported by at least one reference outside of the textbook, either supporting or refuting the position of the author of the forum topic response or peer response.

Student 1 Lisa

Financing a Firm with Equity and Debt

Debt and equity are the two main methods of raising business capital. Equity financing entails selling some business stake to investors in return for capital (Berk & Demarzo, 2012). For instance, a company intending to fund its expansion through equity financing means that it is willing to offload part of its ownership to investors. This can be 10 percent of the company or any other proportion based on valuation or agreement between the transacting parties. Transferring a stake to an investor in exchange for capital means the investor gains part of the company’s control. A salient benefit of equity financing is the lack of obligation to pay back the funds acquired as capital (Berk & Demarzo, 2012). This allows the business to focus its financial resources on growth, essentially working hard to ensure it generates sufficient returns for investors. However, while equity financing is considered the most ideal, it also has its downside. Equity financing means that the owners have to relinquish part of their business control, therefore, are no longer independent in decision-making (Sulfia, 2015). Additionally, the process of equity financing is more complex given the needs of business valuation and agreeing on the fair value of the stake, among other needs (Berk & Demarzo, 2012).

On the other hand, debt financing involves borrowing money on interest to fund the business. Loans are commonly utilized in this type of financing. One of the better parts of debt financing is the faster and less complex of raising these resources, as it only requires the lender to build credibility on the borrower (Berk & Demarzo, 2012). Once the lender trusts the borrower, funds are easily disbursed. Another benefit of debt financing is that the business owner retains full control over the business since the lender’s only claim is repayment of the loan and interest (Sulfia, 2015). However, one major downside of this type of financing is the periodical repayments, which further strain business earnings (Berk & Demarzo, 2012). Secondly, debt financing comes with exposure to insolvency risk in case of default (Berk & Demarzo, 2012). Nonetheless, it is common for businesses to combine debt and equity financing methods in their capital structure, based on their needs.

References

Berk, J., & DeMarzo, P. (2012). Corporate finance. Person Education Limited

Sulfia, D. J. (2015). An insight into equity and debt financing: Analytical study on capital structure. Anchor Academic Publishing

Student 2

Cost of Capital

Cost of capital is the amount of money a business must spend to get funding for projects. The weight and cost of a company’s debt and equity are taken into account when calculating the cost of capital at the corporate level. (Cost of capital, 2023) Because it acts as a measure of new initiatives, cost of capital is an essential indicator. For instance, a business will evaluate the anticipated return on investment against its predicted cost of capital when deciding whether to invest in a new facility or expand the plant. In order to assess the cash flow from investment opportunities, investors can also use the cost of capital as a discount rate.

(e weighted average cost of capital (WACC) is the most common method for calculating cost of capital.(Saalmuller, 2022)

WACC = (E/V x Re) + ((D/V x Rd) x (1 ))

Where:

E: Market value of firmàequity

D: Market value of firmàdebt

V: Total value of capital (equity + debt)

E/V: Percentage of capital thatàequity

D/V: Percentage of capital thatàdebt

Re: Required rate of return

Rd: Cost of debt

T: Tax rate

The cost of capital provides investors with a quick indication of the types of returns they can anticipate from a firm because, in most cases, these shouldn’t pursue initiatives that would yield returns below its cost of capital. Simply put, the cost of capital refers to the rate of return that investors expect in exchange for lending money to a business. These costs of capital can be used by investors to evaluate what the market anticipates from a company.

Cost of capital is a metric that both management teams and investors consider when determining whether a new project or investment is worthwhile. The venture might be profitable if anticipated profits exceed the projected cost of capital. On the other hand, the project will not be anticipated to provide additional value if the returns on the money invested were less than the cost of obtaining that cash. 

Cost of capital. Corporate Finance Institute. (2023, March 13). https://corporatefinanceinstitute.com/resources/va…

Saalmuller, L. (2022, May 19). Cost of capital: What it is & how to calculate it: HBS Online. Business Insights Blog. https://online.hbs.edu/blog/post/cost-of-capital#:~:text=One%20common%20method%20is%20adding,the%20total%20amount%20of%20debt.