I have attached an essay written by one of my classmates. I need a reply in about 200 words. Referneces are important
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Abraham Karikuzhiyil – Monday, 14 May 2018, 1:21 PM
The Cost of Capital Dilemma in an Organization
Harriet’s decision is certainly not correct because even the retained earnings of the organization
have a cost. Retained gains in these cases are the amount of money proportioned to the total net
profits, which is distributed among shareholders; however, they are further flowed back to the
business. Razmerita, Kirchner, & Nielsen, (2016) argues that, despite the fact that these kinds of
money do not have a direct outflow of cost in the equality case and cash outflow, plus debts, they
lack the opportunity cost. The retained earnings do not cost free source of funding, and the actual
cost of the retained earnings is more or less equal to the rate of return to the owners or instead
shareholders and the reinvestment of dividends paid by the organization or company. This,
therefore, mean that retained earnings to some extent have the same cost, like that of the common
equity, which in this case study is 15%. It, therefore, brings no difference to the organization even if
they use the retained earnings instead of the thirteen percent-weighted average cost of capital. As
the vice president, it has no need considering her suggestion since it has no change or benefit to the
No, this is not a good idea.
This is because, as I started in the above paragraph, the total cost of retained earnings to some
extent equal to the value of the return to the owners. In the subsequent case, the total cost of the
common equity is just a mere 15%. This portrays that the sole decision would make the weighted
average cost of capital of her thought eleven percent, which is alternatively more than the expected
return of ten percent from the expansion. It is true, and my answer is yes as the various capital
projects are required to have their own cost of capital rates for budgeting. This is however contrary
to the application of weighted average cost of capital or rather the equity capital cost calculated by
CAPM since different projects can have varying risk levels. It is, therefore, a typical idea when every
project’s cost capital is required to reflect on the risk of the expansion project and not the associating
to the firm’s average project reflected in the composite weighted average cost of capital. Despite the
fact that WACC is a method of valuing many of the projects, however, it is in most cases dependent
on the risk factor associated with it. This, therefore, portrays that if a project has either high or low
risk, then WACC will have to adjust upwards or sometimes downs to account for the differential
risks. For access to all the playing field, the premium of risk has to be considered individually due to
the different risks involved in the whole project. Concerning this particular project, a regular basis
accounting for all the specific risk factors by, which a correct estimate of the cost of capital can be
made accessible to the viability of the project. Management must always check out very keenly
when dealing with issues to do with management. The decisions they make must depend on the
consent of all the board members and if there is no board, then better a channel of decision must be
established to ensure all decisions are keen and of benefit (Rey, 2015)
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