Week 5 Case Study
Can you make poor investment decisions and be profitable? What evidence do you see from the companies’ results that indicate how well they made investment decisions (capital budgeting).
A company can make poor investment decisions and still remain profitable, but only for a time. A company cannot continually make poor investment decisions and remain profitable forever.
When looking at the Coke vs Pepsi case study, we find that Doug Ivester, then CEO of Coke, made a bad investment decision when he chose to increase the rate charged for syrup to franchisers. As a result, bottlers raised prices to improve profitability, and in turn there was a decrease in overall sales volume. During the time Ivester was CEO, the net income for Coke fell 41% and he ended up without a job. Had this been a trend that continued, Coke would have been out of business, but they rebounded and remain profitable. This example shows that a company can make a bad decision and continue to be profitable in the long run. But, repeat bad investment decisions and a company will go broke.
How does WACC change over time? What do you think might drive the changes?
WACC is the opportunity cost of investing in a company, or the expected return of shareholders and debt holders. WACC consists of all capital sources and includes common stock, preferred stock, short-term debt and long-term debt in the calculation. WACC is the average costs of capital financing, and tells us how much a company has to pay for each dollar of financing.
WACC for any company will fluctuate over time. As WACC consists of both debt and equity, there are a number of factors that drive changes in WACC, and can be divided into internal and external factors. Internal factors, controlled by the firm, include the firm’s dividend policies, investment policies, and capital risk structure. The percentage of earning paid out as