There are always many factors a company might encounter which can impact the rate of return or cost of capital.
There are always many factors a company might encounter which can impact the rate of return or cost of capital. The cost of capital is stated to represent the weighted average cost in financing the company for future economic growth (Block et al., 2019, p. 341). There are many ways in which a company can implement the capital structure and weigh its cost of capital. To determine the weight of the cost of capital, one is required to analyze the cost of debt, preferred stock, and common equity. Also, the rate of return is defined as the risk in investment associated with individual security (Block et al., 2019, 304). Cost of capital and rate of return allows companies and investors to calculate their opportunities and risks. When a firm could earn a rate of return that is greater than the cost of capital, it might depict as a good investment time for a certain financial manager. However, the rate of return factors risk determines if a project risk is sufficient to move forward. To understand a company’s rate of return there needs to be an analysis of equity and debt for corporate expansion (Investopedia). A financial manager is required to see if the project will be a long-term economic gain for the company. If the rate of return was greater than the cost of capital for a company, it can have the potential of being a short-term result that might cause the company a loss of revenue in the long term. For example, providing dividends to shareholders can be a cost that might harm the company’s cost of capital. To prevent making the wrong call, a financial manager will need to use the following steps to make the proper decision during the rate of return and cost of capital comparison:
1. Present value of future cash flow
2. Required rates of return by investors/Valuation
3. Cost of financing to the firm
4. Analysis of project based on the cost of financing to the firm (Block et al., 2019, p. 304)
A couple of factors that a financial manager should use to assist in making the right call will consist of the cost of debt, cost of preferred stock, cost of common equity, required returns on the common stock, cost of common equity, cost of new common stock, size of capital structure retain earnings and lower-cost debt (Block et al., 2019, p. 359). This will allow for an individual to compare corporate tax rate, annual dividends, price of stock, risk rate return, retained earnings, and amount of lower-cost debt and make the proper decision. The ratio of both costs of capital and rate of return will provide a calculation of future opportunities at a risk expense.
Resources:
Block, S. B., Hirt, G. A., & Danielson, B. R. (2019). Foundations of financial management (17th ed.). Retrieved from https://www.vitalsource.com/
Cost of Capital vs. Required Rate of Return: What’s the Difference? (n.d.). Investopedia. https://www.investopedia.com/ask/answers/020415/what-difference-between-cost-capital-and-required-return.asp
Answer preview to there are always many factors a company might encounter which can impact the rate of return or cost of capital.
APA
294 words