Part 1: Interest Rates
Many managers do not understand the various ways that interest rates can affect business
decisions. For example, if your company decided to build a plant with a 30-year life and shortterm debt financing (renewed annually), the cost of the plant could skyrocket if interest rates
were to return to their previous highs of 12% to 14%. On the other hand, locking into high, longterm rates could be very costly also with a long period when low short-term interest rates were to
be available. As you can see, the ability to know your economic environment and its impact on
projected interest rates can be crucial to making good financing decisions.
Describe two to three macroeconomic factors that influence interest rates in general. Explain the
effects of each factor on interest rates.
Now think about the industry in which you are employed or one in which you have past
experience. To what macroeconomic factors is your industry most sensitive?
Describe two contemporary factors that seem to be impacting your industry today, and identify
their impacts on the interest rates experienced within your chosen industry.
Support your comments with your own experiences, the weekly resources, and/or additional
research. Use APA throughout and provide appropriate in-text citations and references.
Part 2: Stock Valuation, Risk and Returns
Risk and Returns
The links above contain information on stock valuation, risk and returns. Please review each one
of them. Based on the knowledge gained from the materials presented in the links above,
complete the following activities:
Present a detailed discussion of what you learned about stock valuation. Provide examples of
how your company have used the concepts. Do you believe financing a company's operation
using stock is better than financing with bonds? Why or why not? Support your discussion with a
Based on the materials presented in the “Risk and Return” video, present a discussion on why the
materials are important in financial decision making. How would you incorporate risk and return
in your financing decisions?
In the link below, you will explore how companies compute their cost of capital by computing a
weighted average of the three major components of capital: debt, preferred stock, and common
equity. The firm's cost of capital is a key element in capital budgeting decisions and must be
understood in order to justify capital projects. In addition, you will also learn capital budgeting
techniques including Payback, Net Present Value, Internal Rate of Return, etc.
Cost of Capital:
For this Discussion, imagine the following scenario:
You are the director of operations for your company, and your vice president wants to expand
production by adding new and more expensive fabrication machines. You are directed to build a
business case for implementing this program of capacity expansion. Assume the company's
weighted average cost of capital is 13%, the after-tax cost of debt is 7%, preferred stock is
10.5%, and common equity is 15%. As you work with your staff on the first cut of the business
case, you surmise that this is a fairly risky project due to a recent slowing in product sales. As a
matter of fact, when using the 13% weighted average cost of capital, you discover that the
project is estimated to return about 10%, which is quite a bit less than the company's weighted
average cost of capital. An enterprising young analyst in your department, Harriet, suggests that
the project be financed from retained earnings (50%) and bonds (50%). She reasons that using
retained earnings does not cost the firm anything, since it is cash you already have in the bank
and the after-tax cost of debt is only 7%. That would lower your weighted average cost of capital
to 3.5% and make your 10% projected return look great.
Based on the scenario above, post your reactions to the following questions and concerns:
What is your reaction to Harriet's suggestion of using the cost of debt only? Is it a good idea or a
bad idea? Why? Do you think capital projects should have their own unique cost of capital rates
for budgeting purposes, as opposed to using the weighted average cost of capital (WACC) or the
cost of equity capital as computed by CAPM? What about the relatively high risk inherent in this
project? How can you factor into the analysis the notion of risk so that all competing projects
that have relatively lower or higher risks can be evaluated on a level playing field?
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