1. "the problem is how to motivate managers to disgroge the cash rather than investing it below the cost of capital or wasting it on organisational inefficiencies". Explain now debt finance can provide a solution to this problem.
2. An executive of a mining company explains that it has a policy of maintaning a portfolio of projects at various stages of development. in this way the need for external finance is minimised because the cash flow generated by operating mines can be used to finance development of new ones. Also the company's net cash flow can be smiithed by adjusting production plans to suit the timing of new projects. For example, if there are delays in bringing a new mine into production, the life of an old mine might be extended by ming low -grade ore that would not normally be consider economic.Critically evaluate the company's strategy from the viewpoint of shareholders.
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1. "The problem is how to motivate managers to disgroge the cash rather than investing it below the cost of capital or wasting it on organizational inefficiencies". Explain now debt finance can provide a solution to this problem.
A firm's optimal capital structure is that mixture of debt and equity than minimizes its weighted average cost of capital (WACC). Since the after-tax cost of debt is lower than equity for many corporations, why not use debt only or mostly? It turns out that, while debt reduces a company's tax liability because interest payments are deductible expenses, increasing amounts of debt raise both the cost of equity capital and the interest rate on debt ...
This discusses the company's strategy from the viewpoint of shareholders