In regards to the second question, I have on my flash cards that optimal capital structure is reducing WACC and maximizing share price. I hate these questions…
AA
I think A & C as well. You can have a high cost of capital and still have a very valuable company (high stock price) if the company can invest that capital and achieve above normal returns.
Per Schweser… The objective of a company’s capital structure decision is to determine the optimal proportion of debt and equity financing that will minimize the firm’s weighted average cost of capital (WACC). This is also the capital structure that will maximize the value of the firm. … I hate this test.
Sponge_Bob_CFA Wrote: ------------------------------------------------------- > AA > > westbruin…minimizing WACC doesn’t imply that > you have to forego positive NPV calculations. > Minimizing WACC is not a static concept, it will > fluctuate given capital needs at the time as well > as market conditions…it is the mix of debt, > common & pfd stock that minimizes your cost of > capital. the concept is a little unclear in the readings. but there is a section that has the word static in its title… but they never really come around to saying either of our positions. think about it. if your WACC is 8% and a new project comes with 20% Return, are you going to turn it down because it may raise your WACC… if you assume that the firm will undertake these 4 projects and that’s it, then yes you will minimize your WACC. but that’s the static part.
Minimizing WACC will lead to Maximizing Share Price (all else held equal). Think about all the equity discounting models.
Wow, for an easy and straightforward question, it sure is bring up a lot of debate. High stock price does not mean the firm is valuable, ala Worldcom and Enron.
westbruin Wrote: ------------------------------------------------------- > Sponge_Bob_CFA Wrote: > -------------------------------------------------- > ----- > > AA > > > > westbruin…minimizing WACC doesn’t imply that > > you have to forego positive NPV calculations. > > Minimizing WACC is not a static concept, it > will > > fluctuate given capital needs at the time as > well > > as market conditions…it is the mix of debt, > > common & pfd stock that minimizes your cost of > > capital. > > the concept is a little unclear in the readings. > but there is a section that has the word static in > its title… but they never really come > around to saying either of our positions. > > think about it. if your WACC is 8% and a new > project comes with 20% Return, are you going to > turn it down because it may raise your > WACC… if you assume that the firm will > undertake these 4 projects and that’s it, then yes > you will minimize your WACC. but that’s the static > part. No, don’t think of minimizing WACC as the primary driver in all business decisions. In utopia a firm would undergo all positive NPV projects. You’ve already taken the increased WACC into consideration when you performed the NPV calculation (that is why you would use the project WACC in the analysis). Now, given that they’ve determined that a project is worthy of undertaking (+NPV) it would strive to use the mix of debt/common/pfd that would minimize the WACC. A minimized WACC would lead to a maximum stock price (all else equal). Remember all NPV projects will have an IRR that exceeds their cost of capital (WACC) so you are creating value for stakeholders.
Sponge_Bob_CFA Wrote: ------------------------------------------------------- > Minimizing WACC will lead to Maximizing Share > Price (all else held equal). Think about all the > equity discounting models. but “all else held equal” implies static… first, i hate these questions… but to me, i read that the firm won’t do new projects due to an excessive focus on WACC. i’m thinking her firm doesn’t understand is that the returns they’re giving up higher returns on projects. of course, the other interpretation is that the firm needs to change its capital structure. to me, maximizing (sustainable) share price is the ultimate goal. WACC is just a means to it… although i will admit CFA sure doesn’t dwell on maximizing share price.
trek7000 Wrote: ------------------------------------------------------- > Wow, for an easy and straightforward question, it > sure is bring up a lot of debate. High stock > price does not mean the firm is valuable, ala > Worldcom and Enron. I’m pretty sure they mean share price as value.
The “all esle equal” was to imply that markets were efficient and were pricing securities based on an equity discount valuation model, not some shape in charts that resembles what a day trader would normall drink coffee out of.
lets hope the real exam will be clear compared to good ol schit-ser
Finance 101- The objective of any firm is to maximize shareholder wealth(ie stock price). That being said I still think the answer is A
However, they weren’t asking what the objective of the firm was…they asked what the objective of the optimal capital structure was.
So is the second one A or C?
^^ Right, thats why I think the answer is A
gauravji!! post the easy and straightforward answer please…and end all debate…
LanceTX Wrote: ------------------------------------------------------- > ^^ Right, thats why I think the answer is A Sorry, I missed that.
The suspense is killing me!!! The “easy and straightforward” question is a 2 page debate lol!!!
The answers are A and C. The explanation provided on the website is not very convincing. However, as most of our fellow members have posted that stock value makes more sense. Also, they have already mentioned that the firm is already facing high cost of capital. They are from Allen Resources website. Also, one more issue is that yesterday they provided answer as A and A and today they provided answer as A and C. This is a bit ambiguous again. So I believe neither Dinesh nor Riot need to retire. We need your fruitful and intelligent discussions.