Reference no: EM131314818

Company Cash

Companies are valued in different ways. One way to determine what the market value of a company is by using the Weighted Average Cost of Capital, or WACC. The WACC is simply the rate a corporation must earn to keep the return positive for their investors (Henderson, 1979). If a company is struggling to maintain viable cash flow, they have many options available to them. They can raise more capital through bonds, bank notes, preferred equity and common equity.
Bonds

While there are some differences between stocks and bonds, companies are wise to use both to raise much needed capital. As with any investment, there are different levels of risk and reward with bonds. High risk can bring high reward, but it can also bring high losses. "The capital asset pricing model suggests that the mix with the best prospects for the future, considering both expected return and risk, will include bonds and stocks in proportion to outstanding market values" (Sharpe, 1973).

Bank Notes

Another way to raise capital is by issuing bank notes. A bank note is risky though, and it does not gain any interest. However, it can be presented by a customer at any time for its original value (Gorton, 1999). It allows to company to have cash up front, that they can hopefully turn into profit. That profit will then be used to repay the debt.

Preferred Equity

A favorite of investors is preferred equity. Preferred equity is usually a direct investment into the company. They tend to have a fixed, preferential return that can be distributed back to the investors prior to other distributions. One downside of preferred equity is that it tends to lack documentation. However, they are becoming more and more popular for both investors and companies (Heller, 2012).

Common Equity

If preferred equity is the favorite for investors, common equity is the opposite for many companies. Common equity an expensive way to raise capital. There are usually fees involved and unique pressures of supply and demand from existing shares. One way that companies can manage that cost is by choosing the right exchange to issue it through. While the Security and Exchange Commission (SEC) is mandate by law to protect investors; the reality is that the market itself may impose tougher sanctions than the SEC (Bethel & Krigman, 2008).

Conclusion

WACC is one of the more favorable ways to value a company. However, you cannot just use it in any way you wish. However, is used correctly, "WACC-based real-option valuation as an alternative to risk-neutral-based real-option valuation...may be preferable for educating associates, clients, and colleagues about risk-neutral pricing" (Arnold & Timothy, 2004). Much like the wise woman of Proverbs 31, companies and investors both need to do quality research before attempting to raise capital. "She considereth a field, and buyeth it: with the fruit of her hands she planteth a vineyard" (Proverbs 31:16, King James Version).