choose Variables for a sensitivity analysis, Finance Basics

Assignment Help:

You are asked to select three variables for a sensitivity analysis of weighted average cost of capital, what would you choose and why?

  • Weighted average cost of capital is the average of the required return required by each providers of finance. Funds can be provided by common stock holders or debt holders. Common stock holders charge equity rate of return and debt holders charge a debt rate of return.
  • Equity rate of return is calculated using following formula:

Expected return = risk free rate + beta (Market rate minus risk free rate)

Debt holders simplycharge a percentage say 10% per annum.

Weighted average cost of capital is then calculated based on the amount of each equity and debt used in the total capital

  • Now based on the above formulas, the three variables for sensitivity analysis of weighted average cost of capital could be:

(a)    Risk free rate = The risk free rate is the rate paid by US treasury on sovereign bonds. Now this rate may change and change the equity rate of return. Specially during times of crisis, the risk free rate fluctuates as the governments try to reduce the impact of recession on the economy. High risk free rate will lead to high equity rate of return and high weighted average cost of capital and vice versa.

(b)   Market rate - This is generally based on the returns generated by the broad market index such as SNP 500 etc. These may change based on how the index is performing. During boom periods, they generate better returns as compared to bad periods. High market rate will lead to high equity rate of return and high weighted average cost of capital and vice versa.

(c)    General interest cost in the country - This is based on the general interest rate declared by central bank of various countries such as Federal Reserve of USA plus appropriate premium. Central banks lend money to various commercial banks at the general rate of interest and then these commercial banks add suitable market risk premium depending upon on the risk involved in the project. Hence, general rate of interest will lead to higher rate of debt and higher weighted average cost of capital and vice versa.


Related Discussions:- choose Variables for a sensitivity analysis

The equity discount rate , Assume IBM pays out all earnings as dividends. ...

Assume IBM pays out all earnings as dividends. Today is t = 0 and IBM just paid a $2 dividend on $2 of earnings. The market expects dividends will grow each year by 5% until t = 4

Calculate the ex-right stock price, DIY Inc. plans to raise $200,000 with a...

DIY Inc. plans to raise $200,000 with a right offering. The current stock price is $100 and there are 80,000 shares outstanding.  a. If DIY sets the subscription price to be $80

Sole proprietorship, Sole Proprietorship Definition - A sole proprietor...

Sole Proprietorship Definition - A sole proprietorship or sole tradership is the oldest and simplest form of business. It is that type of business organization where one person

Explain financial funds and supply , What does it mean to say that individu...

What does it mean to say that individuals as a group are net suppliers of funds for financial institutions? What do you think the consequences might be in financial markets if indi

Money market mutual funds (), why i cant found date for mmmfs like total as...

why i cant found date for mmmfs like total asset or number of share or return ???? i search alot and i found words instead of number

Managing financial resources, Two friends, Alan & Tim just graduated from t...

Two friends, Alan & Tim just graduated from the college. They plan to start their own business, of selling health foods for office workers. They have identified a commercial comple

Types of partners, Types of Partners 1. General Partners -Unlimited ac...

Types of Partners 1. General Partners -Unlimited active and liability in participation in partnership activities. 2. Limited partners - Limited liability in the management of

Selection of remuneration policy, Selection of Remuneration Policy Th...

Selection of Remuneration Policy The alternative of a suitable remuneration policy through a company will depend, with another thing, on: 1. Cost: the extent to that the p

Explain the term - giving margin money to broker, Explain the Giving Margi...

Explain the Giving Margin Money to Broker Marin  is  the  amount  of  money  which is provided  by customer to the brokers who have agreed to trade their securities. It may

Methods of analyzing investment, Methods of Analyzing Investment Capit...

Methods of Analyzing Investment Capital Budgeting Methods There are two process of analyzing the viability of such investment as: a) Traditional process Pay

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd