Capital Structure, Cost of Capital, and Weighted Average Cost of Capital

Module 4 Journal
Name
Institutional Affiliate
Module 4 Journal
Memo
To:
From: Financial Analyst
Date: 
Subject: Capital Structure, Cost of Capital, and Weighted Average Cost of Capital
Provided herein is a detailed response to your inquiry that sought clarification on the importance and the role of the company’s capital structure. The memo breaks down the key elements of the organization’s capital structure to better understand the financial computations involved in ensuring the smooth running of the firm’s daily operational activities.
* Cost of Capital
* Capital Structure
Capital makes one of the key factors of production for any business setting or organization. Business entities have both human and financial capital through which they run or carry out daily operations towards gaining profits and revenue generation CITATION Tit13 \l 1033 (Titman, 2013). Sustainable growth and development of the organization demand continuous profitability and revenue generation. Achieving and maintaining such an outcome further requires the organization to remain competitive by making investments across different opportunities identified in the market. The organization finances the said investments through a wide range of sources, including both internal and external sources. External sources of finance may include loans and bonds, whereas issuing or selling shares to the public and using the company’s retained earnings make up the internal sources of financing investments CITATION Tit13 \l 1033 (Titman, 2013). The company’s value of shares issued to the public is also known as equity, while the acquired loans make up for the organization’s debts as indicated in the balance sheet. Both debt and equity function to provide long-term financing of the company’s investments and thus remain competitive in the market. Maintaining a positive balance between the company’s debt and equity maximizes its intrinsic value, thus requiring an effective structure CITATION Alj18 \l 1033 (Aljamaan, 2018). The capital structure thus refers to how an organization maintains the balance between the debt and equity capital financing sources towards positively influencing its market value.
* Cost of Capital
The interaction of debt and equity in the company’s capital structure plays a significant role in influencing the firm’s cost of capital and market value. Proposed investment projects by the organization make the company use either internal or external sources of capital financing. The company uses both debt and equity to finance its investment projects for sustainable growth and development through business expansion CITATION Tit13 \l 1033 (Titman, 2013). The firm gauges the value of the investment by analyzing and evaluating both the risk and cost incurred relative to the expected returns from the business expansion project CITATION Alj18 \l 1033 (Aljamaan, 2018). If, for instance, the firm incurs or rather accumulates more debts to finance its expansion projects, then it tends to put the firm at higher risk. A higher debt capital further translates t...