Table of Contents
What does cost of capital tell us?
The cost of capital is the expected return to equity owners (or shareholders) and to debtholders. So WACC tells us the return that both stakeholders can expect. WACC represents the investor’s opportunity cost of taking on the risk of putting money into a company.
Under what conditions will IRR and NPV be consistent when accepting or rejecting projects?
The decision rule for NPV is to accept the project if the NPV is positive and reject the project if the NPV is NPV is negative. The decision rule for IRR is to accept the project if the IRR equals or is greater than the required rate of return and reject the project if the IRR is less than the required rate of return.
Under which of the following situations should the IRR decision rule be avoided?
Under which of the following situations should the IRR decision rule be avoided? -A project with multiple rates of return. -Project NPV does not decline smoothly as discount rate increases. You just studied 35 terms!
What is a good cost of capital?
There is typically lots of debate about this number but generally it falls between 10-12%. The risk-free rate is the return you’d get on a risk-free investment, such as a treasury bill (somewhere between 1-3%). This figure can also be debated. Note how important the beta can be.
Why is cost of capital important for a firm?
The cost of capital aids businesses and investors in evaluating all investment opportunities. It does so by turning future cash flows into present value by keeping it discounted. The cost of capital can also aid in making key company budget calls that use company financial sources as capital.
What increases capital cost?
When the demand for capital increases, the cost of capital also increases and vice versa. The demand is influenced greatly by the available market opportunities. If there are a lot of production opportunities in the market, more and more entrepreneurs will explore those opportunities to create profitable ventures.
What circumstances will the IRR and NPV rules lead to the same accept reject?
There are two conditions in which the NPV and IRR decision will be the same. They are: i) If the projects are independent and the cash inflow of the projects are positive without even a single negative cash flow during the life of the project both NPV and IRR will give the same result.
Should a firm invest in projects with NPV $0?
Should a firm invest in projects with NPV = $0? IF a project’s NPV is 0, accepting the project will neither increase shareholders’ wealth nor destroy shareholders’ wealth, so the firm will be indifferent between accepting or rejecting the project.
Why is higher IRR better?
Essentially, the IRR rule is a guideline for deciding whether to proceed with a project or investment. The higher the projected IRR on a project—and the greater the amount it exceeds the cost of capital—the more net cash the project generates for the company. Generally, the higher the IRR, the better.
Which of the following would not have an impact on the IRR of a project?
Which of the following would NOT have an impact on the IRR of a project? This is the correct answer! IRR is the discount rate at which the net present value of an investment equals zero. Weighted average cost of capital does not impact IRR.
How does capital structure affect cost of capital?
Alterations to capital structure can impact the cost of capital, the net income, the leverage ratios, and the liabilities of publicly traded firms. The cost of equity is typically higher than the cost of debt, so increasing equity financing usually increases WACC.
Which matter is not considered in cost of capital?
The firm’s overall cost of capital is based on the weighted average of these costs. For example, consider an enterprise with a capital structure consisting of 70% equity and 30% debt; its cost of equity is 10% and the after-tax cost of debt is 7%.