Los 25.a Flashcards
(13 cards)
What is the WACC and how do you calculate it?
WACC (Weighted Average Cost of Capital) is the average rate a company is expected to pay to finance its operations through a mix of debt and equity. It reflects the cost of each capital component, weighted by its proportion in the company’s capital structure.
Calculaiton: WACC = [weight of debt × pretax cost of debt × (1 – tax rate)] + (weight of equity × cost of equity)
A WACC of 8.3% means that the company’s average cost of financing (through a mix of debt and equity) is 8.3% per year. In other words, for every dollar the company raises from investors (both debt holders and equity investors), it needs to generate at least 8.3% return on its investments to meet the expectations of its investors (debt holders and shareholders).
What’s the difference between internal and external capital structures?
Internal factors include the characteristics of the business or industry, a company’s life cycle stage, a company’s existing debt level, and the corporate tax rate.
External factors include market and business cycle conditions, regulation, and industry norms.
What charactersitciis influence the proportion of debt in a capital structure
Growth and stability of revenue. High growth of revenue or stability of significant revenue suggest a continuing ability to service debt.
Growth and predictability of cash flow. Growing cash flow increases the ability to service debt. Significant and stable cash flows indicate a continuing ability to service debt.
Amount of business risk. More business risk (operational risk and demand risk) means greater variability of earnings and cash flows, which decreases the ability to service debt.
Amount and liquidity of company assets. Assets can be pledged as collateral to make a company’s debt more attractive. When assets are more liquid (easier to turn into cash, values more stable), they can be pledged more readily.
Cost and availability of debt financing. Companies find de
what companies can have a higher amount of debt?
Companies in noncyclical industries are better able to support high proportions of debt than companies in cyclical industries.
Companies with low fixed operating costs as a proportion of total costs (i.e., low operating leverage) are better able to support high proportions of debt than companies with high fixed costs.
Companies with subscription-based revenue models are better able to support high proportions of debt than companies with pay-per-use revenue models.
What role do assets play in a company’s ability to take on debt?
Tangible, liquid, and fungible assets are viewed as better collateral for debt than intangible assets, improving access to debt financing.
How does the cost and availability of debt financing influence a company’s capital structure?
Companies find debt more attractive when it is lower in cost, and lenders are more willing to lend, especially when a company’s debt is secured by assets.
How does the stability of a company’s revenue and cash flow affect its capital structure?
Companies with stable, predictable revenues and cash flows are more capable of handling high levels of debt, as they can service it reliably.
How do business cycles and economic factors affect capital structure decisions?
In downturns, credit spreads widen as lenders demand higher yields to compensate for default risks, especially for companies in cyclical industries.
What is the capital structure of companies in the start-up stage?
In the start-up stage, companies are typically financed with equity due to low or negative revenues and high risk. Convertible debt and leasing are other options.
What is the capital structure of companies in the growth stage?
Companies in the growth stage use more debt financing as revenues and cash flows increase, often secured by assets like accounts receivable or fixed assets.
What is the capital structure of companies in the mature stage?
In the mature stage, companies have significant, stable cash flow, making them capable of taking on low-cost debt, including unsecured debt.
How does the type of assets affect a company’s debt financing?
Companies with tangible assets (like property or machinery) are in a better position to take on debt because these assets can be pledged as collateral, making borrowing easier.
How does inflation or economic downturns impact capital structure?
