fm10 13 - netted out when determining investment needs that...

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Mini Case: 10 - 13 a. 1. What sources of capital should be included when you estimate Harry Davis’ weighted average cost of capital (WACC)? Answer: The WACC is used primarily for making long-term capital investment decisions, i.e., for capital budgeting. Thus, the WACC should include the types of capital used to pay for long-term assets, and this is typically long-term debt, preferred stock (if used), and common stock. Short-term sources of capital consist of (1) spontaneous, noninterest-bearing liabilities such as accounts payable and accruals and (2) short- term interest-bearing debt, such as notes payable. If the firm uses short-term interest- bearing debt to acquire fixed assets rather than just to finance working capital needs, then the WACC should include a short-term debt component. Noninterest-bearing debt is generally not included in the cost of capital estimate because these funds are
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Unformatted text preview: netted out when determining investment needs, that is, net rather than gross working capital is included in capital expenditures. a. 2. Should the component costs be figured on a before-tax or an after-tax basis? Answer: Stockholders are concerned primarily with those corporate cash flows that are available for their use, namely, those cash flows available to pay dividends or for reinvestment. Since dividends are paid from and reinvestment is made with after-tax dollars, all cash flow and rate of return calculations should be done on an after-tax basis . a. 3. Should the costs be historical (embedded) costs or new (marginal) costs? Answer: In financial management, the cost of capital is used primarily to make decisions which involve raising new capital. Thus, the relevant component costs are today's marginal costs rather than historical costs....
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