Northern+Forest+Products - Hello Student, Before...

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Hello Student, Before approaching the questions that you have requested help with, let me start by giving you a brief overview of the capital budgeting process, especially as it relates to capital structure, cost of equity, cost of debt and the weighted average cost of capital. The capital structure of a corporation is the way in which it decides to finance its assets through a combination of either debt and/or equity. Note the following excerpt: “The capital structure is how a firm finances its overall operations and growth by using different sources of funds. Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. When people refer to capital structure they are most likely referring to a firm's debt-to-equity ratio, which provides insight into how risky a company is. Usually a company more heavily financed by debt poses greater risk, as this firm is relatively highly levered.” Source: A firm for example, who decides to sell $40m in equity and $60m in debt would be considered as being 40% equity-financed and 60% debt-financed. The firm's ratio of debt to total financing, in this example would be calculated as 60% and this is referred to as the firm's leverage. It is claimed that the concept of capital structure is very important as, ‘it can influence not only the return a company earns for its shareholders, but whether or not a firm survives in a recession or depression.” This return that its shareholders will receive comes at a cost to the firm and is often referred to as the cost of equity. The return that its bondholders or other debt holders of the firm will receive is the cost of debt. For further explanation of both the cost of debt and
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the cost of equity (and how to calculate), you may visit Cost-of-Capital.htm . One other thing which you need to refresh your memory on before attacking these three questions is the weighted average cost of capital. You may note the following excerpt (taken from the link in the previous paragraph): “Businesses can't mint money. One choice is to borrow money, either from a bank or through a bond sale. Another option is to sell a piece of the business through
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This document was uploaded on 03/26/2012.

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Northern+Forest+Products - Hello Student, Before...

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