Cost of Capital in Chile - Essay Example

The paper "Cost of Capital in Chile" is a good example of an essay on macro and microeconomics. The increased need of funds for business expansion forces multinational corporations to accept capital from foreign resources. Even though sources of foreign capital would help the MNCs to acquire adequate funds for further growth, it must consider various factors when financing from a foreign source. It is necessary to conduct a detailed market analysis in order to forecast global market fluctuations which may cause currency loss to MNCs. So companies must make essential strategic amendments in order to receive foreign resources only from almost stable economies. Similarly persisting interest rates and taxation policies must also be examined to discover the most appropriate foreign sources; otherwise, these ‘unaffordable costs associated with the foreign sources may weaken the ultimate purpose of foreign capital acquirement’ (Fort, G. R. & Budnevich, 1997, p.17). In addition to this, the interference of the foreign investor also weakens the performance of MNC as it badly affects the sustainability of the organization. 

Let us take Nucor Corporation, a leading steel company of America, as an example in order to explain the calculation of the rate of return from capital investment which is essential to valuate the cost of capital. Build-Up method (BUP) and Capital asset pricing model (CAPM) method are two important methods of capital cost valuation since it gives an almost accurate picture of the cost. The Build-Up method considers the cost of capital as the value of external risks from investment. In the Buildup method, a sequence of possible return factors is added and the sum total represents the future returns from the capital investment. On the other hand, as Hall (2005) states, capital asset pricing model method provides for the ‘explicit relationship between the expected rate of return on an asset and the systematic risk of holding that asset’ (p.20). So, these methods have great importance in the process of capital investment since it helps the Nucor Corporation to assess the gains from the venture. Generally, companies like to invest in productive assets more than in traded market securities since it gives more priority to the yields from investment. Cost of capital is an implicit cost; moreover, it is a concept that makes some changes in the company’s balance sheet. It is recorded in the balance sheet as an opportunity cost which the company would have obtained if it were invested in the next available project. For instance, assume that a firm invests $1000 000 in Nucor Corporation with the condition that it would be returned as $120 000 at the end of the year. We can assume that the firm was possible to acquire an annual return of 10% if the money had invested in government bonds. Then, it is clear that the opportunity cost represents 10% as a result of the investment in the project. It actually becomes the cost of the project if it does not include any additional expenses like transaction costs or taxes. So, according to Patterson (1995), it is necessary to notice that the cost of capital or the opportunity cost is considered as an asset even though the capital appears on the liability side of the balance sheet ( p.2). Hence in the case of the Build-Up method, all probable income factors are added and this figure plays a role in the treatment of the balance sheet. Under the system of Capital asset pricing model method, risk factors are also considered for the balance sheet purpose. Proper care must be given for the computation of the cost of capital as it is not an explicit cost. However, the elimination of these items from the balance sheet adversely affects the accuracy of the financial statement.  Read More