discuss corporate concepts of WACC, NPV, IRR and working capital decisions and s
ID: 2797807 • Letter: D
Question
discuss corporate concepts of WACC, NPV, IRR and working capital decisions and shows how all these ideas are implemented in practice. The hot topic on Wall Street is the collapse of commodity prices this year, especially the price of oil and gas, and the $1.5Trillion reduction in capital expenditures Here's your topic to discuss: What are the ramifications to the US economy as whole when corporate America decides NOT to invest/spend that kind of money? Are there cascading effects not only to oil and gas stakeholders but the ancillary businesses? FinExplanation / Answer
WACC is weighted average cost of capital for a firm or the company. It is a main factor affecting the capital budgeting decision for the firm. Every Firm needs capital for investment in the business. However, this capital can be raised either through external financing known as Debt or through internal source of finance known as retained earnings or equity. For Debt, a firm has to pay interest. While equity also has implied cost. A firm has to decide optimum mix of Debt and Equity in financing decision so as to minimize WACC. WACC acts as required rate of return for the firm and it is used as a benchmark for minimum return that the firm should get from any of it's investment. In real world scenario, a firm has a limited capital invest and multiple projects to choose from to decide which one to invest in. There are certain tools which are used to decide which project to choose and which project to exclude for investment. NPV i.e. Net Present Value is nothing but present value of all future cash inflows discounted at WACC for the firm less cash outlflow. It is the decision rule for selection of project to invest. The firm should choose the project with highest NAV to invest. IRR or internal rate of return is one more tool to decide whether to invest in a project or not. IRR is the discount rate which results in NPV of Zero. Thus a project should invest in a project of its WACC is less than IRR. If WACC is higher than IRR then firm should not invest into such project as it will result in negative NPV. Working Capital decisions are based on sources of finance to build level of current assets for the firm. Either by way of internal sources i.e. retained earnings or credit from supplier or through Bank Borrowing in order to minimize the cost of finance. Due to collapse in commodity prices, especially in Oil and Gas & significant reduction in quantum of Capital Expenditure, there will be adverse ramifications on the US economy in terms of overall demand and growth. As the oil and gas is the basic input to all the heavy industries, the adverse impact on these commodities will have cascadig effect on other industries and overall industrial output. Reduction in capital expenditire will result in lower investment, lower output and economy will move into recessionary phase.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.