Weightedaverage cost of capital and capital structure

These days the world community is fast coming to terms with the recessionary trends in almost all sectors. The corporate world is under severe pressure to cut costs and do justice with the existing workforce.On the one hand companies are trying to gain valuable support from the respective governments. while on the other hand, all efforts are being made to do away with undue expenditures, and making the capital structure optimal in efficiency. Weighted Average Cost of Capital (WACC) is a fundamental approach towards making the capital structure the most advantageous for the company. No doubt companies might have undertaken such exercise many a times in the past, but the manner in which the industry is experiencing the pressure in today’s context, makes it all the more necessary for the companies to have a relook at some of the policies and procedures for calculating the WACC. Therefore, this study is an effort to analyze the procedures adopted for calculating the weighted average cost and how companies make use of such calculations in arriving at sound financial decisions for their investment plans.Managers are supposed to make strategic moves on the basis of both external and internal analysis. They have to control costs and manage money for the ongoing operations as well as for the futuristic investments. This could be in the form of preparing or reviewing budgets, expense reports, or travel authorizations. It may be cash management or sales management. For financial management, markets and environments are assessed. Internally, operating and financial capabilities of the company/ organization are analyzed by using the hard facts, i.e. the financial statements, budgets etc.

Investment decisions happen to be quite crucial for a company and its business operations. Entrepreneurs often face the dilemma of adopting one type of capital structure as compared with alternatives available. There are a number of stakeholders involved in a business proposition. Besides the financial resources, the enterprise requires the support of human capital, intellectual capital, relationship capital etc. (Fletcher et al, 2003). While the efforts for optimizing other types of capital requires more of intellectual capital and internal control, the financial decisions for the company require a sound understanding of the fiscal position prevailing within the country/ region, the market position and the strategies being adopted by the competitive companies. The Weighted Average Cost of Capital therefore proves to be a handy tool in dealing with the financial decision and finding out the rate of returns that the company can expect in due course. The long term planning decisions taken with the help of WACC can also be reviewed during the course of operations, if it is found out that the actual figures are widely at variance with the expected rates of returns. The calculations of weighted average cost of capital involves according proportionate weight to each category of capital sources like, common stock, preferred stock, bonds and any other long-term debt1.

Managerial economics demands analysis of current and actual costs. In the cost-benefit analysis opportunity cost also emphasizes the role of judgment. Computerized calculation can be done while analyzing the financial details of one’s own company,