How Companies Make Financial Decisions

Published: 2021-07-02 15:31:56
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Vanderbilt University
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Problem solving
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Financial decisions is inclusive of financial forecasting and wealth management that helps investors and businesses attain their financial goals. In this case we are going to evaluate how stock valuation, total returns, capital asset pricing model, weighted average cost of capital and floatation costs influence making decisions in finance.

Stock valuation helps an investor determine the value of his shares and makes decisions whether to buy or sell. Under this case the shares would be worth purchasing as the shares market price have risen by 25% which is the capital gains with a dividend yield of 2% and a total return of 27% hence it is more profitable investing in the shares.

Considering the total returns which measures where the company is making losses or profits, 24% remarkable gain was calculated and therefore the company best decision is investing more so that the total rate of returns can also increase.

According to David (1982) capital asset pricing model helps the risk averse investors increase their investments. It also defines the cost of equity and expected rate of return on companys stock where expected return is the shareholders opportunity cost of the equity funds employed by the company. The relationship between returns and beta is linear and positive hence high risk equals high rate of return and low risk leads to low returns. In the calculations the final rate of return was 13.4% which is 1.4% higher than what was expected but its low. The company would rather increase the risk rate and invest more for higher returns.

The weighted average cost of capital is the cost of capital a company will pay for using capital of the owners. As shown above the company WACC is 7% hence the companys debt are not too much and they can decide to invest more on the stock.

Floatation costs is the amount a company incurs when making new issue of stock.it will help a company budget for their project as they will know the amount of capital needed. In the above calculation the company must have $137.5 for the project to be a success.

References.

David W.M., (Jan, 1982).Does the Capital Asset Pricing Model Work Financial analysis.

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