Financial decisions1/4/2024 The formula for the same is:įinancing Decisions and Investment Banking Once we have these two components, we can bring them together to calculate the WACC (based on the long-term capital structure of a company). Stated below is the CAPM Model, which is used to calculate the cost of equity: In order to establish the WACC of a business, we need to consider the cost of debt, which is based on market rates.Īfter establishing the cost of debt, we need to consider the cost of equity (Ke) – using the Capital Asset Pricing Model (CAPM) Investment banks can help companies in their financing decisions.įinancing Decisions, Cost of Debt, Cost of Equity, and WACC.To calculate the WACC, we need to calculate the cost of equity and cost of debt, and the proportion of debt and equity in the capital structure.If a company wants to create shareholder value, its financing decisions should ensure that the WACC remains lower than its ROIC.As part of financing decisions, companies aim to minimize their cost of funding while maintaining a stable credit rating and the ability to finance new projects. If a company wants to create value for shareholders, it needs to ensure that it’s ROIC (Return on Invested Capital) is greater than the WACC. The financing decision seeks to optimize the WACC by looking at a company’s capital structure, specifically the cost of equity and the cost of debt. Further, the cost of capital is an important ingredient in the valuation of a company by investors. For any investment worth undertaking, the expected return on capital must be greater than the cost of capital i.e. An integral part of financial decisions is the consideration of the cost of capital, which companies must take into account. This plays a very important role vis-a-vis financing its assets, investment-related decisions, and shareholder value creation. Financing decisions refer to the decisions that companies need to take regarding what proportion of equity and debt capital to have in their capital structure.
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