Cost of capital

Running Head: COST OF CAPITAL
Cost of Capital
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Introduction:
For any company to operate, it needs assets which signify the wealth of the company. These assets when used by the company produce the returns that determine the overall profitability of a company. A company will thus look to determine the most cost effective method of acquiring assets such that the returns are more than the costs. This way the company is able to replace the assets when they wear off and give a decent financial return to the owners of the company.
Thus a company will be driven by factors including the cost of and the benefits that accrue to a capital structure in determining the ideal capital structure. This will also depend on the industry the company plays in, the management affinity to a particular capital financing avenue and the overall ability of the company to generate income from the capital employed.
Discussion:
When faced with the choice of determining the ideal capital structure of an organization, management will either take the decision to have a low debt ratio, a medium debt ratio of a high debt ratio. However, it is worth to note that the level of debt ratio is highly subjective and human driven. This means that for two managers operating in the same industry, having company’s with similar operation dynamics, a debt ratio of 20% could be viewed by one as low and another as high.
Ford motor company produces cars and trucks. As such the nature of its operations requires heavy investment in production equipments. These equipments have to be versatile and easily adoptable to changing times. Using this alone as a basis of determining the capital leverage of a company then Ford motors would ideally require to be highly leveraged. This is on the assumption that motor production does not change every so often. This is to mean there is relative stability in terms of designs and production processes. However in its operations, it has incorporated a credit component which offers financing facilities both to retail consumers as well as dealers within the Ford distribution chain. With this mind, Ford Motors needs a high debt ratio. Given that in its operations it is not exposed to extremely fluid environments as is the case of operations in the internet industries, coupled with the relatively high incidence of certainty of operations, a high debt ratio is ideal for Ford Motors. As such, given its equity base, Ford Motors can finance most of its operations on debt capital. This allows for a more long term projection and emphasis when securing debt financing.
It is imperative in the other hand to make sure that the interest on the debt is lower that the Ford Motors ability to generate income from its operations. The high debt ratio offers to Ford Motors some unique advantages in its operations. Given its long and stable history in relation to revenues, earnings and cash flow, ...