2. Describe the difficulties that companies that companies such as Lilyhammer might encounter when attempting to calculate their WACC.
The difficulties could be summarized as follow: using wrong discount rate and growth rate (g).
The cost of capital (hurdle rate) is the cost of funds that a company raises anduses, and the return that investors expect to be paid for putting funds into thecompany and therefore is the minimum return that a company must make onits own investments to earn the cash flows out of which investors can be paid their return (pre corporate tax). The cost of capital is an opportunity cost of finance – it is the minimum returnhat investors require. If they do not get this return, they will transfer some orall of their investment elsewhere. So when shareholders invest in a company the returns they can expect must be sufficient to persuade them not to sell some or all of their shares and invest somewhere else (general discussion the consequences of using wrong discount rates). Also, The yield on investment is the opportunity cost to the investors of not investing elsewhere. Thus current market prices must be used to establish the costs of the various elements of long-term capital. Nominal (historical) valuesare irrelevant. Market values also reflect the importance (i.e., weighting) ofthe different forms of finance.
3. Critically evaluate the suggestions of the finance director, the managing director and the production director.
In the consideration of the return rate of the project, the rate can not be lower than the WACC, so that Finance directors should fully considered the return rate.
For the position of the management director, it should pay attentions on the management cost which is also related the cost of the project, the costs are associated with the travelling costs and office expenses.
In a position of the production director, he should fully be considered on the cost of the project such as the direct materials and overheads cost.
Q3 Question 3
Financial leverage is the degree to which a company uses fixed-income securities such as debt and preferred equity. The more debt financing a company uses, the higher its financial leverage. A high degree of financial leverage means high interest payments, which negatively affect the company's bottom-line earnings per share.
This figure represents assets minus liabilities. There are some businesses that are funded entirely with equity capital (cash written by the shareholders or owners into the company that have no offsetting liabilities.) Although it is the favored form for most people because you cannot go bankrupt, it can be extraordinarily expensive and require massive amounts of work to grow your enterprise.
This type of capital is infused into a business with the understanding that it must be paid back at a predetermined future date. In the meantime, the owner of the capital (typically a bank, bondholders, or a wealthy individual), agree to accept interest in exchange for you using their money. Think of interest expense as the cost of “renting” the capital to expand your business; it is often known as the cost of capital.
Financial risk is the risk to the stockholders that is caused by an increase in debt and preferred equities in a company's capital structure. As a company increases debt and preferred equities, interest payments increase, reducing EPS. As a result, risk to stockholder return is increased. A company should keep its optimal capital structure in mind when making financing decisions to ensure any increases in debt and preferred equity increase the value of the company.