Posted: November 28th, 2022
After watching the video, answer the following questions in your post:
Guided Response: Review several of your colleagues’ posts, and reply to at least two of your peers by 11:59 p.m. on Day 7 of the week. In your written responses to your classmates, address the following:
Post by classmate 1
Did Alex Clark initially fund the business with equity or debt?
She primarily started the business with her own money which shows that she did not start with debt she started with equity.
Initially, Clark’s chocolate business is very small. Compared to publicly traded companies, would Clark’s required rate of return on equity be higher or lower than the “average” required rate of return on equity for small cap companies of 15%? Explain your answer.
The required rate of return would be lower than the average because she is not working with much debt to begin with. This makes it so she can work on building the company and not paying off debt over time.
After the business was established, Clark talked about buying a building to expand. This is a good example of an investment project that a business must evaluate. Would the required rate of return for Clark’s building purchase be higher or lower than the overall chocolate company’s required rate of return? Explain your answer.
The overall rate of return should be lower because there is less going into it. All they really needed was a retail space to be able to sell what they make. This is missing from there previous retail space that worked as there kitchen as well.
Should Clark use some bank debt to finance all or a portion of the building purchase? Justify your answer by explaining how the weighted average cost of capital for the company would change if Clark uses bank debt to finance all or a portion of the building purchase.
Clark can use some bank debt just because they really don’t have any debt to begin with. This makes it so there WACC is super low, which allows for them to have allot of wiggle room in how much they can do with bank financing.
What is the primary risk that Clark faces if she uses debt to finance the entire building purchase? For purposes of this discussion, assume that the debt would then comprise 95% of the company’s capital structure.
Then what she could run into is the defaulting on the loan she has taken out. This would be primarily caused by her not having enough money to be able to pay down the debt effectively
Hickman, K. A., Byrd, J. W., & McPherson, M. (2013). Essentials of finance. Bridgepoint
Post by classmate 2
Alex Clark initially funded the business with equity since she used her own money. She would not have to pay a bank or financial institution back since the funds were hers.
The larger cap a company is, the lower the required rate of return. This is because larger cap organizations are less risky. Since Clark’s business is very small, the required rate of return would need to be higher since the business is very risky and investors would want to ensure they do not lose money.
The required rate of return for the new building should be higher than that of the chocolate company. This is because there is more risk in not knowing how and if the building would succeed.
I think it might be beneficial for Clark to look at the bank’s options. If she uses a portion of bank debt, the WACC would decrease helping her increase profits.
The primary risk to finance most of the building with bank debt is Clark could potentially default on her debt. If she acquires too much debt, her business could be at jeopardy.
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