Weighted-average cost of capital and capital structure - Essay Example

Dissertation Proposal Weighted-Average Cost of Capital and Capital Structure 2. Rationale of the study These days the world community isfast coming to terms with the recessionary trends in almost all sectors. The corporate world is under severe pressure to cut costs and do justice with the existing workforce. On the one hand companies are trying to gain valuable support from the respective governments; while on the other hand, all efforts are being made to do away with undue expenditures, and making the capital structure optimal in efficiency. Weighted Average Cost of Capital (WACC) is a fundamental approach towards making the capital structure the most advantageous for the company. No doubt companies might have undertaken such exercise many a times in the past, but the manner in which the industry is experiencing the pressure in today's context, makes it all the more necessary for the companies to have a relook at some of the policies and procedures for calculating the WACC. Therefore, this study is an effort to analyze the procedures adopted for calculating the weighted average cost and how companies make use of such calculations in arriving at sound financial decisions for their investment plans. 3. Objectives of the study The study in general aims to; i. Find out the importance of WACC in strategic decision making for a company ii. Analyze the components leading to calculation of the Weighted Average Cost of Capital iii. Figure out the parameters which can be calculated using the WACC and how the risk factors are minimized to the business operations of the company. iv. Find out the factors outside the control of the company leading to far reaching effects on the WACC v. Find out ways and means which can help a company in effectively controlling the WACC. 4. Background of the study (Initial Literature Review) Managers are supposed to make strategic moves on the basis of both external and internal analysis. They have to control costs and manage money for the ongoing operations as well as for the futuristic investments. This could be in the form of preparing or reviewing budgets, expense reports, or travel authorizations. It may be cash management or sales management. For financial management, markets and environments are assessed. Internally, operating and financial capabilities of the company/ organization are analyzed by using the hard facts, i.e. the financial statements, budgets etc. Investment decisions happen to be quite crucial for a company and its business operations. Entrepreneurs often face the dilemma of adopting one type of capital structure as compared with alternatives available. There are a number of stakeholders involved in a business proposition. Besides the financial resources, the enterprise requires the support of human capital, intellectual capital, relationship capital etc. (Fletcher et al, 2003). While the efforts for optimizing other types of capital requires more of intellectual capital and internal control, the financial decisions for the company require a sound understanding of the fiscal position prevailing within the country/ region, the market position and the strategies being adopted by the competitive companies. The Weighted Average Cost of Capital therefore proves to be a handy tool in dealing with the financial decision and finding out the rate of returns that the company can expect in due course. The long term planning decisions taken with the help of WACC can also be reviewed during the course of operations, if it is found out that the actual figures are widely at variance with the expected rates of returns. The calculations of weighted average cost of capital involves according proportionate weight to each category of capital sources like, common stock, preferred stock, bonds and any other long-term debt1. Managerial economics demands analysis of current and actual costs. In the cost-benefit analysis opportunity cost also emphasizes the role of judgment. Computerized calculation can be done while analyzing the financial details of one's own company, but in order to analyze the competitor's financial strength, the market situation, the environmental factors etc. the role of strategic management becomes quite crucial. Weighted average cost calculations help in arriving at such judgments. To arrive at a final decision and to plan out a futuristic strategy all these factors play a crucial role. 5. Methodology The methodology adopted for carrying out a research activity provides an important direction to the research and has the potential to impact the final outcome. This in turn implies that the research approaches and methods can radically influence the policies designed in response to the outcome of the research. Research philosophy is a belief about the way in which data about a phenomenon should be gathered, analyzed and used. This thesis is a qualitative as well as quantitative case study focusing on an analysis of the financial decisions made by a company and how the calculations of weighted average can indeed help the company in arriving at strategic decisions. The discussion on the background dictates that this study would involve the analysis of some companies and their financial figures and ratios and how such figures and ratios have been utilised by the companies for their long term planning purposes. To carry out such a study in general we resort to two main approaches; Deductive approach: This works from the more general to the more specific subjects. Sometimes this is informally called a "top-down" approach. In such approach we take up the 'theory' and then try to apply it to the hypotheses that we intend to test. Gradually we narrow down to the testing of data and observations for their applicability to the theory/ theories to arrive at a confirmation of its applicability or not. The Inductive approach on the other hand begins with collecting data, specific observations, which then leads to broader generalization and theories. Such an approach is called as "bottom up" approach. The patterns thus detected are formulated into tentative hypotheses and we can therefore arrive at some general conclusion about our subject. It helps when the study happens to be a balanced mix of both these approaches. 6. Timeframe Efforts would be made to complete the different modules of the project leading to the completion of the project as per the following timeline (Note-These are completion dates). Submission of Proposal: March 12, 2009 Interaction with the Tutor: March 16, 2009 Inclusion of suggestions by the tutor March 17, 2009 Preparation of questionnaire: March 25, 2009 Data gathering, Lit Review etc April 15, 2009 Compiling the Modules April 20, 2009 Review of all details and requirements April 23, 2009 Submission of the Project April 25, 2009 References: 1. Fletcher, Anne; James Guthrie and Peter Steane (2003). 'Mapping stakeholder perceptions for a third sector organization'. Journal of Intellectual Capital Vol. 4 No. 4. MCB UP Limited 2. Investopedia (2009). 'Weighted Average Cost Of Capital - WACC'. Available online at http://www.investopedia.com/terms/w/wacc.asp (Feb 28, 2009) Read More