Cost of Capital
Why is it important for firms to consider the cost of capital when making decisions to invest in long-term projects? Explain what sources of funds should be considered in computing the weighted average cost of capital (WACC) and why it is important to consider WACC rather than the cost of just one source of financing. Provide an example of a major investment by your employer, or a large firm in Saudi Arabia you are familiar with, and explain what factors were probably considered in establishing a required rate of return on the investment and why. Search the internet for an academic or industry-related article. Select an article that relates to the cost of capital and doing business in Saudi Arabia.
For your discussion post, your first step is to summarize the article in two paragraphs describing what you think are the most important points made by the authors (remember to cite the information, as appropriate).
Cost of capital is that the needed come necessarily to form a capital budgeting project. Many firms use a mix of debt and equity to finance their businesses and, for such firms, the general cost of capital comes from the weighted average cost of all capital sources, widely known as the weighted average cost of capital (WACC).The cost of capital metric is employed by corporations internally to evaluate whether or not a capital project is definitely worth the expenditure of resources, and by investors who use it to work out whether or not an investment is definitely worth the risk compared to the return. The value of capital depends on the mode of funding used. It refers to the value of equity if the business is supported exclusively through equity, or to the value of debt if it is supported exclusively through debt.
Cost of capital focuses on the long-term investment decisions as funded by long-term liabilities or equity. When considering the debt component, the cost of debt for a new investment equals the cost of borrowed funds. In other words, if a firm purchases a new piece of equipment by borrowing the money from a bank, the cost of capital equals the interest rate on loan plus any transaction costs (Keown et al., 2017).The weighted average cost of capital (WACC) is a calculation of a firm’s price of capital within which every class of capital is proportionately weighted. All sources of capital, including common stock, bonds, preferred stock, and any other long-term debt, are included in a WACC calculation. A firm’s WACC increases as the beta and rate of return on equity raise because an increase in WACC indicates a reduction in valuation and an increase in risk.
Saudi Basic Industries Corporation (SABIC) is a global leader in the production of different chemicals, offering highly diversified products, including petrochemicals, agricultural nutrients, metals, and specialty products. Factors that a company determines when determining a desired rate of return are:…
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