Discussion Managing Finance

Explain with examples how the cost of capital is determined.

There are several ways to determine the cost of capital. “Capital can be obtained from investors or from creditors” . Capital is obtained through investors when they invest in the business through shares of stock. The investors will receive payment in the form of dividends and when the shares of stock increase in value. Creditors supply capital by giving the organization loans. They receive payment through interest and period principle payments.

Companies have different ways of getting capital. “The required rate of return on each capital component is called its component cost, and the cost of capital used to analyze capital budgeting decisions is found as a weighted average of the various components’ costs” . A company can find their weighted average, or overall cost of capital. This will show the organization what their WACC is. This is a weighted average of relatively low-cost debt and high-cost equity.

Calculate the differences in cost and risks. Explain why the costs and risks of external financing are important for the organization to understand.

Risks refer to an organization’s ability to manage its debt and financial leverage. Costs will refer to whether or not a company will be able to make enough profit to sustain its operational costs.

A company must have a robust understanding of both of these of external financing. It needs to have an understanding before making any decisions when it comes to the cost and the risks of the company. The organization must have a repayment strategy already in place from the beginning. Understanding this will make the company take on good debt and not bad debt. Taking on good debt will make the company grow and become more successful whereas taking on bad debt will have the opposite affect. Understand risk and costs will allow the company to make these types of decisions.

Explain why rapid growth plans are important to a small company. Would there be a more efficient way to fund a growing company?

Rapid growth is normally a good thing. For a small business it could be good or bad. Rapid growth normally gives the company more available resources, more capital for which to operate, and greater visibility. It is important that the smaller business has a plan in order to make sure the rapid growth is going to work for them. It is a very balanced issue with making and spending money.

A smaller company that is growing at a rapid pace has several options to get financing. One could be a small business loan. Depending on the growth and the capital needed this could be a very good option for an organization. A company could show the lender the success and the rate at which the company is growing. This would make it much easier to get a loan. If the company could lock in at a low interest rate then this option could be a much cheaper options than going public and selling stocks. As long as the business can back up how it plans on maintaining the growth, they should have no problem getting a small loan from a bank or other institution.