capitalization

Examples of capitalization in the following topics:

• The Marginal Cost of Capital

  • The marginal cost of capital is the cost needed to raise the last dollar of capital, and usually this amount increases with total capital.
  • The marginal cost of capital is calculated as being the cost of the last dollar of capital raised.
  • Generally we see that as more capital is raised, the marginal cost of capital rises .
  • The Marginal Cost of Capital is the cost of the last dollar of capital raised.
  • Describe how the cost of capital influences a company's capital budget

• Decision Criteria

  • The main considerations of working capital management decisions are (1) cash flow/ liquidity and (2) profitability/return on capital.
  • Working capital is the amount of capital which is readily available to an organization.
  • In addition to the time horizon, working capital decisions differ from capital investment decisions in terms of discounting and profitability considerations; they are also "reversible" to some extent.
  • Firm value is enhanced when, and if, the return on capital, which results from working-capital management, exceeds the cost of capital, which results from capital investment decisions as above.
  • Cash conversion cycle is a main criteria for working capital management.

• Cost of Capital Considerations

  • Cost of capital is important in deciding how a company will structure its capital so to receive the highest possible return on investment.
  • One of the major considerations that overseers of firms must take into account when planning out capital structure is the cost of capital.
  • For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital.
  • The weighted average cost of capital multiplies the cost of each security by the percentage of total capital taken up by the particular security, and then adds up the results from each security involved in the total capital of the company.
  • Describe the influence of a company's cost of capital on its capital structure and investment decisions

• Optimal Capital Structure Considerations

  • The optimal capital structure is the mix of debt and equity that maximizes a firm's return on capital, thereby maximizing its value.
  • One of the major considerations that overseers of firms must take into account when planning out capital structure is the cost of capital.
  • For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital.
  • The weighted average cost of capital multiplies the cost of each security by the percentage of total capital taken up by the particular security, and then adds up the results from each security involved in the total capital of the company.
  • Explain the influence of a company's cost of capital on its capital structure and therefore its value

• Role of Financial Markets in Capital Allocation

  • One of the main functions of financial markets is to allocate capital, matching those who have capital to those who need it.
  • One of the main functions of financial markets is to allocate capital.
  • Capital markets especially facilitate the raising of capital while money markets facilitate the transfer of liquidity, matching those who have capital to those who need it.
  • When a company borrows from the primary capital markets, often the purpose is to invest in additional physical capital goods, which will be used to help increase its income.
  • Long-term capital can come in the form of shared capital, mortgage loans, and venture capital, among other types.

• Evaluating Interest Rates

  • The interest rate most commonly used in working capital management is the cost of capital.
  • The cost of capital, in a financial market equilibrium, will be the same as the market rate of return on the financial asset mixture the firm uses to finance capital investment.
  • Firm value is enhanced when, and if, the return on capital, which results from working-capital management, exceeds the cost of capital, which results from capital investment decisions.
  • As mentioned, working capital decisions are made with the short-term in mind.
  • Interest rates of working capital financing can be largely affected by discount rate, WACC and cost of capital.

• Calculating Expected Value

  • Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital.
  • Net working capital is calculated as current assets minus current liabilities.
  • If current assets are less than current liabilities, an entity has a working capital deficiency, also called a "working capital deficit. "
  • We can find working capital by:
  • The common commercial definition of working capital for the purpose of a working capital adjustment in a mergers and acquisitions transaction (i.e., for a working capital adjustment mechanism in a sale and purchase agreement) is equal to:

• Defining the Cost of Capital

  • The cost of capital is used to evaluate new projects of a company, as it is the minimum return that investors expect for providing capital to the company.
  • Thus, the cost of capital is a benchmark that a new project has to meet.
  • For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital.
  • A more specific calculation of cost of capital is the weighted average cost of capital.
  • The cost of capital serves as a benchmark in financial decision-making.

• Impact of the SML on the Cost of Capital

  • The plotted location of an instrument on the SML has consequences on its price, return, and cost of capital it contributes to a firm.
  • Companies often turn to capital markets in order to generate funds -- using the issuance of either debt or equity.
  • The cost of obtaining funds in such a manner is known as a company's cost of capital.
  • This would not be an attractive market situation for a company looking to raise capital.
  • Describe the impact of the SML on determining the cost of capital

• Working Capital

  • Along with fixed assets, such as plant and equipment, working capital is considered a part of operating capital.
  • Net working capital is calculated as current assets minus current liabilities.
  • If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit.
  • Decisions relating to working capital and short-term financing are referred to as working capital management.
  • The management of working capital involves managing inventories, accounts receivable and payable, and cash.