Core Activity A Flashcards
(44 cards)
What is Weighted Average Cost of Capital (WACC)?
WACC is the average cost of capital from all sources (debt and equity), weighted by their proportion in the firm’s capital structure. It reflects the minimum return a company must earn to satisfy its investors.
Why is WACC important for investment appraisal?
It is used as the discount rate for evaluating project cash flows. A project is accepted if its return exceeds WACC, ensuring value creation for shareholders.
What affects WACC?
Capital structure (debt vs equity mix), cost of debt (interest rates), cost of equity (investor expectations), and tax rates.
How is the cost of debt calculated?
Based on interest payments and redemption value, adjusted for tax savings since interest is tax-deductible. Formula: Cost of Debt = Interest × (1 – Tax Rate).
How is the cost of equity estimated?
Often using CAPM: Cost of Equity = Risk-Free Rate + Beta × Market Risk Premium. It reflects shareholder return expectations.
Why is debt generally cheaper than equity?
Because interest on debt is tax-deductible, and lenders take lower risk than shareholders, requiring lower returns.
What is the risk of using too much debt?
Excessive debt increases financial risk, potentially raising the cost of equity and overall WACC due to investor concerns.
What is the relationship between WACC and project value?
Higher WACC reduces Net Present Value (NPV) of future cash flows. Lower WACC increases the likelihood of project acceptance.
What is a business ecosystem?
A network of organisations (e.g., suppliers, partners, customers) that interact and co-create value. They rely on collaboration and shared resources.
What are the three core elements of a business model (CIMA)?
Define value (understand customer need), Create value (develop products/services), and Deliver value (reach customer via channels).
What is residual value in a business model?
The value captured after delivering goods/services, i.e., revenue minus cost. It represents profit or shareholder value.
What is digital disruption?
The impact of new digital technologies and models that transform industries, potentially displacing established companies (e.g., Uber, Netflix).
What is a disruptive business model?
A model that changes the value chain using innovation or tech (e.g., streaming services replacing physical media sales).
What strategies can firms use to adapt to digital disruption?
Build internally, Buy (acquire), Partner with innovators, Invest in startups, or Incubate/accelerate new ventures.
How do you prioritise stakeholders in business models?
Use criteria: Power (influence), Legitimacy (stake in outcome), and Urgency (timeliness of needs).
How is value created and delivered in ecosystems?
Through resource sharing, trust, process integration, and output alignment. Firms must ensure customer satisfaction and efficiency.
What does capturing residual value involve?
Ensuring revenues from delivered value exceed the costs of creating and delivering it. It supports profit generation.
What leadership qualities help firms survive digital disruption?
Strategic vision, collaboration skills, external awareness, sound judgment, and investment in talent development.
What is price elasticity of demand?
A measure of how sensitive demand is to price changes:
- Elastic: Small price change → large demand change
- Inelastic: Price changes have little effect on demand
What is cost-plus pricing?
Set price by adding a mark-up to the cost of production. Ensures all costs are covered and a profit margin is made.
What is premium pricing?
Charging a high price to signal superior quality or exclusivity. Used for luxury or differentiated products.
What is market skimming?
Introducing a product at a high price to maximise profit from early adopters, then gradually reducing it.
What is penetration pricing?
Setting a low initial price to attract customers and gain market share quickly. Useful in highly competitive markets.
What is price differentiation?
Charging different prices to different customer segments for the same product, based on willingness to pay or costs.
