Description
“The use of debt to fund the firm (called leveraging) carries with it benefits as well as risks” (Hickman et all., 2013, Chap 8, Overview, para. 4). In the short term, leverage lowers the weighted average cost of capital due to the typically lower required rates of return on debt as compared to equity. In the long run, debt requires interest payments and the principal must be repaid. A firm that cannot repay its debt faces default risk and/or bankruptcy. The risks due to excessive leverage are known as financial risks. Thus, as a firm considers using debt or equity to fund its business, it must consider both the benefits of debt and the financial risks of too much debt. In this discussion, you will evaluate a real-world scenario and consider the implications of the debt financing decision for the firm.
Prepare:
Prior to beginning work on this discussion forum,
- Complete the the Week 5 – Learning Activity: Understanding Cost of Capital.
- Read Chapter 10 in Essentials of finance
- Read Chapter 8: Section 8.1: Perfect Capital Markets in Essentials of finance
- Watch the following video:
How Alex Clark Turned $32,000 Into a Chocolate Phenomenon - 30 Under 30 | Forbes
After watching the video, answer the following questions in your post:
- Did Alex Clark initially fund the business with equity or debt?
- Initially, Clark’s chocolate business is very small. Compared to publicly traded companies, would Clark’s required rate of return on equity be higher or lower than the “average” required rate of return on equity for small cap companies of 15%? Explain your answer.
- After the business was established, Clark talked about buying a building to expand. This is a good example of an investment project that a business must evaluate. Would the required rate of return for Clark’s building purchase be higher or lower than the overall chocolate company’s required rate of return? Explain your answer.
- Should Clark use some bank debt to finance all or a portion of the building purchase?
- Justify your answer by explaining how the weighted average cost of capital for the company would change if Clark uses bank debt to finance all or a portion of the building purchase.
- What is the primary risk that Clark faces if she uses debt to finance the entire building purchase? For purposes of this discussion, assume that the debt would then comprise 95% of the company’s capital structure.
Explanation & Answer
Attached. Please let me know if you have any questions or need revisions.
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CLOUD MIGRATION
Alpha Consultants Cloud Migration
Student’s Name
Institution
CLOUD MIGRATION
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Alpha Consoltants is a consultant company that provides consultation advises to
companies and individuals. There are five departments in the company that are
specialized in offering specific information and guidance in Engineering, Information
Technology, Finance, Law and general matters. The clients are mainly other
companies who require the company to analyze their data, and provide them with
insights and intelligent on their company or strategies. The clients also require that
they be provided with solutions and best moves towards given strategic plans or
proposals. Over the past decade, the company has seen rampant expansion and last
year had an increase of 20% in sales. The company wants to expand over different
states in the US. Currently, the company is using homegrown applications and IT
infrastructure. The main servers, routers, databases are all located at the company
headquarters. The impending expansion require the development of new IT
infrastructure for every new site. Moreover, additional software will have to be
designed to coordinate and synchronize all the IT systems in new locations. The new
system is likely to consume an large chunk of its operating capital. As such, the
company stakeholders are opting to move to cloud instead.
CLOUD MIGRATION
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The current systems to be moved to the cloud include the Database server and the
application server. Other functionality and infrastructures will rema...