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Debt & Equity Offerings / Cost of Capital & Decision Making

WACC #1

What role does the cost of capital play in the overall financial decision making of the firm's top managers?

DEBT VS EQUITY #2

Why do you think debt offerings are more common than equity offerings and typically much larger as well?

Solution Preview

In order to approach the first question, the first thing that you need to do is define what is weighted average cost of capital; look at the components that make up the weighted average cost of capital; and then comment on what role it plays in the overall financial decision making of the firm's top managers.

The cost of capital of a firm is the total amount of costs incurred to raise money to acquire assets or other items for the running of the business. It includes both the cost incurred to borrow money from creditors (cost of debt) and the cost incurred to issue stocks (cost of equity). You may note the following excerpt for a further explanation of weighted average cost of capital:

"Broadly speaking, a company's assets are financed by either debt or equity. WACC is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, we can see how much interest the company has to pay for every dollar it finances." Source: http://www.investopedia.com/terms/w/wacc.asp

Cost of capital is a very important concept that is often adopted and used by ...

Solution Summary

In this solution infomation is first provided that defines what is weighted average cost of capital; looks at the components that make up the weighted average cost of capital; and then tells what role it plays in the overall financial decision making of the firm's top managers. Also, information is given which relates to the advantages and the disadvantages of debt offerings as opposed to equity offerings as well as a discussion as to why one is more common than the other. References are provided.

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