GSFM7514 - Accounting & Finance for Decision Making

Name: KANGGADEVI MURTHI

Matric No: MC200912013
Lecture Name: En Roslan & Mdm. Nor Zarina

Forum Discussion
Suppose that your company’s weighted-average cost of capital is 9 percent.
Your company is planning to undertake a project with an internal rate of
return of 12%, but you believe that this project is not a good investment for
the firm. What logical arguments might you use to convince your boss to
forego the project despite its high rate of return? Is it possible that making
investments with expected returns higher than your company’s cost of
capital will destroy value? If so, how?
Answer and Finding From the forum question
My finding and conclusion on the forum discussion is cost capital is surely not a fair
measure when the venture is over the affiliation's typical risk, Also the hypothesis' tolerably
high risk places it underneath the market line. These sort adventure aren't worthy in light of
the fact that benefits may be lower than others with practically identical risk. Other genuine
dispute might be the sort hypothesis is doesn't agree with association destinations. There may
be better venture with higher NPV/s, or the pay is no doubt not going to be as high as
envisioned.
Huge theory of IRR is transient pay will be reinvested at comparable movements of
return. IRR technique acknowledges that the association has additional venture with likewise
appealing potential outcomes wherein set aside transient wages. IRR methodology is about
reinvestment can lead huge capital spending turns. For example consider 2 exercises A and B
with undefined pay risk levels and length similarly as indistinct IRR values 12%. Using
inside movement of return as a powerful benchmark, the heads would feel trust in being
separated towards picking between the two ventures. At any rate it will be blunder to pick
either wander without checking significant reinvestment rate for transient salaries. In the
occasion that Projects B break pay can be redone at regular 9 % cost of capital, while Project
A pay could be reinvested in an engaging assignment of 12% where by Project A clearly
ideal.
I may use the going with carry conflicts to convince my chief to forego the venture
regardless of the way that it’s high movement of return. Adventures may depends upon
various circumstances and conditions which may show up, and isn't our association
community action and it's depend upon various social affairs. Cost of adventure is
unreasonably and laws and rule may change and cause loss of hypothesis. During the venture
stretch of time development may in like manner change and cause loss of hypothesis.
At the same time some logical is if expenditures are above the average risk of the
sector, then capital expense is not an acceptable benchmark. Other than that, investment costs
are too high. Technology could shift, leading in the future to lower revenues. So my finding
also the project is not the main activity of the organisation and depends on other stakeholders.
Is it possible that making investments with expected returns higher than your
company’s cost of capital will destroy value? Yes, it will destroy the value. Investments can
destroy value because they promise returns below those available on similar risk investments.
If a project is against the company's value or priorities, it can harm the company's image. If
the project relies on many possibilities, some of which do not exist, it may damage the
company's value. If the project conducted is seen as a deviation from the core activities of the
organisation, value will be lost.
It is possible to make the hypothesis. If an undertaking venture is against the value or
focus of the associations, it can impact reputation of the firm. If the venture is unnecessarily
hazardous and remember gigantic stake for peril, it can wreck regard. If the venture is
dependent upon different circumstances, some of which may not happen, it can destroy the
assessment of the firm. If the ventures is viewed as a deviation from association's middle
errands, it can demolish worth.
APPENDIX
Internal rate of return
Meaning
The internal rate of return (IRR) is the discount rate which for a given project or expenditure,
makes the net present value of all cash flows (both positive and negative) equal to zero. A
organisation can decide, depending on IRR, to either approve or refuse a project. If a new
project's IRR approaches the acceptable cost of return of a corporation, the project would
most likely be approved. If the IRR falls below the rate of return expected, the project should
be dismissed.
What is internal rate return used for?
The internal rate of return is used to assess programmes or acquisitions. The IRR calculates a
project’s breakeven discount rate or rate of return, which shows the project’s potential for
profitability. An organisation can decide, depending on IRR, to either approve or refuse a
project. If a new project's IRR approaches the acceptable cost of return of a corporation, the
project would most likely be approved. If the IRR falls below the rate of return expected, the
project should be dismissed.
IRR Formula
0 (NPV) = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n
Positive vs Negative IRR
A positive IRR means that the company is able to return some profit to a project or
investment. Meanwhile, a negative IRR will happen if the cash flows of the project are
alternately positive and negative over the planned duration. A negative IRR is representative
of a more dynamic source of cash flow that can make the metric less beneficial. Basically, a
company with negative IRR will make a company investment to decline.

WEIGHTED AVERAGE COST OF CAPITAL (WACC)

What is Weighted Average Cost of Capital ( WACC).
The weighted average cost of capital (WACC) is a measure of the cost of capital of a
corporation in which each capital group is weighted proportionately. The WACC estimate
covers all forms of money, including common equity, preferred stock, shares, and all other
long-term debt. If the beta and rate of return on equity grow, a company's WACC grows
because a raise in WACC signifies a reduction in value and an increase in risk.

User of WACC
When evaluating the valuation of assets and when deciding which ones to follow, stock
analysts often use WACC. For example, in discounted cash flow analysis, in order to derive
the net present value of a firm, one can apply WACC as the discount rate for potential cash
flows. It is also possible to use WACC as a hurdle rate at which businesses and investors can
gauge the return on performance of spent capital (ROIC). In order to conduct economic value
added (EVA) calculations, WACC is also necessary.
Investors may also use WACC as an indication of whether it is worth pursuing an investment
or not. Put clearly, WACC is the minimum appropriate rate of return for its investors at which
a company yields returns. To calculate the personal returns of an investor on an investment in
a stock, simply deduct the WACC from the percentage of the company's returns.

WACC Formula
WACC=E/V ∗ Re + D/V ∗ Rd ∗ (1−Tc) where:

Re = Cost of equity

Rd = Cost of debt

E = Market value of the firm’s equity

D = Market value of the firm’s debt

V = E + D = Total market value of the firm’s financing

E/V = Percentage of financing that is equity

D/V = Percentage of financing that is debt

Tc = Corporate tax rate

IRR VS WACC

The Weighted Average Cost of Capital (WACC) is how much it costs a firm to fund itself
using bondholders, other lenders, and shareholders' capital. WACC is the "required rate of
return" in relation to the IRR formula that a project or investment's IRR must surpass to add
value to the business. This rate of return may also be referred to as a hurdle rate, incentive
price or capital expense.
For instance, if the WACC of an organisation is 10 percent, to add value to the firm, a new
project must have an IRR of 10 percent or higher. If a new project yields an IRR smaller than
10 percent, the capital expense of the business is higher than the estimated return on the
project or investment proposed.
References

1. Folger, J. (2020, January 29). What Is the Difference Between WACC and IRR?
Retrieved July 29, 2020, from
https://www.investopedia.com/ask/answers/062714/whats-difference-between-
weighted-average-cost-capital-wacc-and-internal-rate-return-irr.asp

2. Boundless. (n.d.). Boundless Finance. Retrieved July 29, 2020, from

https://courses.lumenlearning.com/boundless-finance/chapter/the-wacc/

3. https://corporatefinanceinstitute.com/resources/knowledge/finance/internal-rate-
return-irr/