The main goal of every corporate firm is to have a great supply of equity, also the cost of its operation is to be made more effective, efficient, and economically. In another wordless cost.
A lot of financial experts are pointing that a very interesting principle in the world of finance is if one is able to accurately assess a value, therefore the smarter and more careful future decisions will accrue. In the economy, there are transactions and many of those transactions are buying and selling of goods and services. What that means if you are a buyer of an asset you would like to assess the value of the assets that are higher than their costs and not to buy an asset, which overpriced – overestimated assets.
A lot of the other decisions made are in investment projects which can take place in the long run from 1 year to plus 30 years, so if undervalued or overvaluing a project could be detrimental to the corporation. The capital that is being used in those kinds of projects is if a company is a shareholders company, it comes from the shareholders and of course loans, etc. Therefore, the capital that is being invested is expecting a rate of return, which later be allocated to the investors and other participants in the corporation in form of dividends. A good dividend politic the corporation has to take into consideration how and if it would give its shareholders dividends or invest in projects.
For those investment projects to take action a good budget plan will be necessary. The best thing for future planning is a flexible plan, that can allow for better predictions and easier alignment by the end of the fiscal year if and a large percent of the time it would need an alignment. The capital structure of a corporation can be self-generating equity that means the revenue is allocated from sales of goods or services. Other types as we mention in the previous paragraph are for shareholders. There is also an option for loan borrowing from financial institutions such as banks. When the project is moving up if the company chose to be financed from banks later the interest from the loans that were borrowed for the financial companies needs to be paid back.
The indexes that are used to assess a project are NPV (Net Present Value) and IRR (Internal Rate of Return)
- NPV is a great index because it measures the value creation of the investment,
- IRR measures the yield to maturity of the investment - it shows whether or not a potential investment is profitable or not,
- The payback ratio measures the time is needed to pay back the investment.
The cost of capital is a basic concept in the finance of a company. It is used for investment predictions and for business evaluation. This is how we calculate the cost of the capital – WACC (weighted average cost of capital):
E=market value of equity
D= market value of debt
Re=cost of equity
Rd=cost of debt
T=tax rate
For a diversified company, there are as many costs of capital as there are sectors in which the company operates. Similarly, every country or economy has its own specific cost of capital, which is dependent upon the political landscape and macroeconomic risk.