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Author Question: A firm's capital structure and its target capital structure proportions are important determinants ... (Read 359 times)

Caiter2013

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on: Jul 10, 2018
A firm's capital structure and its target capital structure proportions are important determinants of a firm's
  weighted average cost of capital. Explain.
 
  What will be an ideal response?

Question 2

A significant disadvantage of the internal rate of return is that it
 
  A) does not give proper weight to all cash flows.
  B) may have an unrealistic reinvestment assumption.
  C) is expressed as a percentage.
  D) does not fully consider the time value of money.
Foundations of Finance ¦ Keown, Petty, Martin ¦ 9th Edition
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mcarey591

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Reply #1 on: Jul 10, 2018
Answer to Question 1

The reason we calculate a cost of capital is that it enables us to evaluate one or more of the firm's investment
opportunities. Remember that the cost of capital should reflect the riskiness of the project being evaluated, so a firm
should calculate multiple costs of capital when it makes investments in multiple divisions or business units having
different risk characteristics. Thus, for the calculated cost of capital to be meaningful, it must correspond directly to the
riskiness of the particular project being analyzed. That is, in theory the cost of capital should reflect the particular way
in which the funds are raised (the capital structure used) and the systemic risk characteristics of the project.
Consequently, the correct way to calculate capital structure weights is to use the actual dollar amounts of the various
sources of capital actually used by the firm. In practice, the mixture of financing sources used by a firm will vary from
year to year. For this reason, many firms find it expedient to use target capital structure proportions when calculating
the firm's weighted average cost of capital.

Answer to Question 2

B


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Caiter2013

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Reply #2 on: Jul 10, 2018
TY


mcarey591

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Reply #3 on: Jul 10, 2018
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