1. What are main elements in calculating the cost of capital? How does an increase in debt affect it?

How do you identify an organizations optimal cost of capital?

The main elements used for calculating the cost of capital are Market-Based Weights, Market-Based Opportunity Costs, and Forward-Looking Weights and Opportunity Costs (Titman, Keown, & Martin, 2011). The reason for using the Market Based Weights is to properly indicate the market value of the capital. Similarly the Market-Based Opportunity Costs represent a more accurate picture of the capital rate of return based on the market structure rather than simply the raw numbers. An increase in debt increases the need for additional profits thereby increasing the cost of capital. The rate of return required increases with increased debt. A firms optimal cost of capital is found by using the Weighted Average Cost of Capital (WACC). The WACC identifies the firms optimal cost of capital by figuring in all lenders, investors, and accounts used for financing for the firm (Titman et al., 2011). References Titman, S., Keown, A. J., & Martin, J. D. (2011). Financial Management: Principles and applications (11th ed.). Upper Saddle River, NJ: Pearson/Prentice Hall.

2. What is meant by weighted average cost of capital (WACC)? What are some components of WACC? Why is WACC a more appropriate discount rate when doing capital budgeting? What is the effect on WACC when an organization raises long-term capital? The Weighted Average Cost of Capital (WACC) is the average of the required rate of return for investments weighted with market conditions (Titman, Keown, & Martin, 2011). The WACC is calculated by finding the weighted after-tax cost of debt adding it with the weighted cost of preferred stock and the weighted cost of common stock. This is useful as it takes into consideration all of the organizations investments and debts while considering the market fluctuations. Since taxes on debt are tax deductible but dividend payments are not this presents a better outlook on how to finance projects in different manners. By increasing equity the firm may lose the tax advantage of increased debt thereby raising the required rate of return.
References Titman, S., Keown, A. J., & Martin, J. D. (2011). Financial Management: Principles and applications (11th ed.). Upper Saddle River, NJ: Pearson/Prentice Hall.

3. What is an initial public offering (IPO)? How does an IPO allow an organization
to grow financially? When is a merger or an acquisition, instead of an IPO, more appropriate? An Initial Public Offering (IPO) is the first chance for the public to purchase common stock. IPO helps an organization achieve financial goals by raising capital with a shared

ownership in the organization; selling the stock brings in the capital required for new endeavors and financing. Many factors are considered when making the decision to go IPO or Merger & Acquisition (M&A). Control of the company is one factor as with M&A some control of the company will be lost to the new parent company (Francis, Hasan, & Siregar, 2009). The level of control and amount of involvement the purchasing entity has can be a negotiation factor in the M&A contract (Francis et al., 2009). One other important factor is whether any laws or regulations would be costly or cause issues with an IPO. Going public with a company means the company is bound by many more regulations and restrictions than a privately held company are. M&A may be more appropriate for this type of situation. References Francis, B., Hasan, I., & Siregar, D. (2009). The choice of IPO versus M&A: Evidence from banking industry. Applied Financial Economics, 19(24), 1987-2007. Titman, S., Keown, A. J., & Martin, J. D. (2011). Financial Management: Principles and applications (11th ed.). Upper Saddle River, NJ: Pearson/Prentice Hall.