This article discusses how insurance is typically used as a tool to protect an organization against adverse financial consequences
Rebecca Cline
While looking thought the Library, I discovered several articles about capital allocation. The article I decided to analyses for this discussion is titled Insurance and the Corporate Cost of Capital by Monika Wieczorek-Kosmala. This article was published in 2012 in E-Finanse.
This article discusses how insurance is typically used as a tool to protect an organization against adverse financial consequences. The article discusses insurance may be able to reduce the cost associated with the cost of capital due to the influence of not only cost of capital, but also the need for increasing capital. The article looks at both the Weighted Average of Cost Capital (WACC) and the Total Average Cost of Capital (TACC). Insurance is looked at as a retrospective risk financing tool. According to Wieczorek-Kosmala “reduces the need for the balance-sheet capital in a company” (2012, pg. 61). Not only does insurance reduce the needs for capital, but it also “reduce the level of operating risk and thus influences the required returns of the capital providers” (Wieczorek-Kosmala, 2012, pg. 61). Insurance provides and off the balance sheet component when it comes to capital (Wieczorek-Kosmala, 2012). The article found that there is a “possible impact of the insurance on the weighted average cost of capital (WACC), computed with regard to the balance sheet capital structure” (Wieczorek-Kosmala, 2012, pg. 70). Insurance may affect debt and equity finance ratio. The use of TACC may lead to a significant reduction in the cost of capital due to insurance implementation. Although the concept of TACC seems promising, companies should not use it when making financial decisions due to the lack of research (Wieczorek-Kosmala, 2012).
The concepts in the article agree with the concepts presented in the text. The text talks about how an organization can “initially reduce the weighted average cost of capital with debt financing” (Block, et al., 2019, pg. 350), which agrees with what the article states as well. The article goes on to state that debt financing can “reduce the level of operating risk and thus influences the required returns of the capital providers” (Wieczorek-Kosmala, 2012, pg. 61). The text states something similar when it talks about how “the optimal level of corporate debt depends on the business risks faced by the firm and the nature of the assets that the firm employs” (Block, et al., 2019, pg. 351). Overall, the article and text agree with each other.
Based on the findings in this article, the Weighted Average of Cost Capital (WACC) influences investment decisions. According to Wieczorek-Kosmala, the WACC can significantly reduce the amount of balance sheet capital a company needs (2012). When a company is able to reduce the amount of capital required on the balance sheet, they are able to make their leverage ratios more attractive to investors. WACC can be useful for investors, because it will indicate if the company is building or reducing its value (McClure, 2021). The WACC provides and investor with an idea as to what they can anticipate seeing as a return if they were to provide capital to the organization, the investors return should always be higher than the companies WACC (McClure, 2021).
Resources:
Block, S. B., Hirt, G. A., & Danielsen, B. R. (2019). Foundations of financial management (17th ed.). McGraw-Hill Higher Education.McClure, B. (2021, May 25). Investors Need a Good WACC. Investopedia. https://www.investopedia.com/articles/fundamental/03/061103.asp#:~:text=The%20weighted%20average%20cost%20of%20capital%20(WACC)%20tells%20us%20the,providing%20capital%20to%20a%20company.&text=WACC%20is%20useful%20in%20determining,be%20higher%20than%20its%20WACC.
Wieczorek-Kosmala, M. (2012). INSURANCE AND THE CORPORATE COST OF CAPITAL. E-Finanse, 8(1), 61-71. Retrieved from https://www-proquest-com.proxy-library.ashford.edu/scholarly-journals/insurance-corporate-cost-capital/docview/1024132247/se-2?accountid=32521
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