Capital Structure
Introduction
After Mary Francis meeting with investment bankers, we are tasked with finding out the required return for expanding Apix activities to include food packaging. To support Apix leadership, we will explain capital structure and determine weighted average cost of capital (WACC) from the assumption provided by Mary Francis. Furthermore, we will show how WACC and Capital Structure can be leveraged to find out the viability of the capital project. Additionally, we will explain marginal cost of capital. To close, we will make a recommendation on the best approach to apply to project evaluation between capital structure and WACC
Capital Structure
Capital Structure refers to the sources of funding/financing employed by a firm. These sources include debt, equity and hybrid securities (such as preferred stock or more complicated instruments such as convertible bonds and convertible debentures) that are used by the firm to finance its assets, operations and future growth. Capital structure is often considered in terms of leverage and is used as a measure of the firm’s financial risk, and thereby determines its cost of raising capital. For example, debt is often the least costly form of debt for a firm, but a high proportion of debt in its capital structure significantly raises the financial risk that the firm will not be able to meet its debt obligations that are fixed. It also increases the volatility of earnings per share, and the return on equity to investors (Baker and Martin, 2011).
The capital structure of Apix is provided in the first statement. Apix is financed by equity and debt (no preferred stock) in the ratio of 60%:40%. Thus, if for example Apix has secured financing of $100 million, 60% of $60 million of it would be equity, and the rest 40% or $40 million would be debt.
The Weighted Average Cost of Capital (or WACC)
The Weighted Average Cost of Capital (or WACC) is a financial metric used to measure the cost of capital of a firm in each
After Mary Francis meeting with investment bankers, we are tasked with finding out the required return for expanding Apix activities to include food packaging. To support Apix leadership, we will explain capital structure and determine weighted average cost of capital (WACC) from the assumption provided by Mary Francis. Furthermore, we will show how WACC and Capital Structure can be leveraged to find out the viability of the capital project. Additionally, we will explain marginal cost of capital. To close, we will make a recommendation on the best approach to apply to project evaluation between capital structure and WACC
Capital Structure
Capital Structure refers to the sources of funding/financing employed by a firm. These sources include debt, equity and hybrid securities (such as preferred stock or more complicated instruments such as convertible bonds and convertible debentures) that are used by the firm to finance its assets, operations and future growth. Capital structure is often considered in terms of leverage and is used as a measure of the firm’s financial risk, and thereby determines its cost of raising capital. For example, debt is often the least costly form of debt for a firm, but a high proportion of debt in its capital structure significantly raises the financial risk that the firm will not be able to meet its debt obligations that are fixed. It also increases the volatility of earnings per share, and the return on equity to investors (Baker and Martin, 2011).
The capital structure of Apix is provided in the first statement. Apix is financed by equity and debt (no preferred stock) in the ratio of 60%:40%. Thus, if for example Apix has secured financing of $100 million, 60% of $60 million of it would be equity, and the rest 40% or $40 million would be debt.
The Weighted Average Cost of Capital (or WACC)
The Weighted Average Cost of Capital (or WACC) is a financial metric used to measure the cost of capital of a firm in each
References: H. Kent Baker and Gerald S. Martin, Capital Structure and Corporate Financing Decisions – Theory, Evidence and Practice, 2011, Wiley Investopedia, Definition of Weighted Average Cost of Capital – WACC, 2014, retrieved from http://www.investopedia.com/terms/w/wacc.asp Khan and Jain, Financial Management (5th Edition), 200, Tata McGraw Hill