Financial Analysis for Managers - Assignment Example

The WACC takes into consideration the relative weights of each element of the capital structure and presents the predicted cost of new capital for an organization. In this way, the WACC is important for any firm or organization operating as it not only helps them identify the minimum returns they need to earn but also helps them maintain a constant stock price. The WACC also provides greater accuracy and stabilizes fluctuations (Robert Libby, Patricia Libby, 2005). The WACC is also an important decision variable in investment appraisal and capital budgeting.

Every company or firm wants to increase its wealth and earn profits hence it invests wherever it sees an opportunity. To find the profits that would be earned in the future through the investment at present WACC is a very effective tool. WACC helps a firm take on a greater range of projects because with a lower WACC, more projects will have a positive NPV plus it provides greater firm value, and therefore, greater Stock Price because you discount cash flows by a smaller number. Capital expenditures are the allotment of resources to huge, long-term projects.

The capital budget is a declaration of the intended capital expenditures. It is far more than a straightforward listing and is not the "budget" in common sense. Provided the nature of capital expenditures, the capital budget is thought of as a declaration of the goals and strategy of the firm. Formation of the capital budget is an essential assignment that affects and is affected by all other areas of decision-making in a firm. Current and future business situations are the opportunities and constraints through which the goals of the firm are formulated.

The goals force the strategic decisions of the capital budget and financing but likelihood and uniformity with the mutually dependent financing and capital budget decisions must be measured in situating the goals. For projects that are similar to the normal operations of the firm and have a similar risk profile, the opportunity cost can be estimated by the firm's weighted average cost of capital (WACC) (Paul D. Kimmel, Jerry J. Weygandt, Donald E. Kieso. 2006). The WACC is the rate of return that just meets investor expectations, leaving the worth of the shares of the firm unaffected.