Introduction to Capital Budgeting (Essay Sample)

Introduction to Capital Budgeting/Investment Valuation
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Introduction to Capital Budgeting/Investment Valuation
Description of the capital structure
Capital structure is an analysis of the sources of finance that a firm uses to finance its activities. A company services its capital requirements from several sources. This source include the owners’ equity and debt. The equity of the firm is divided into common stocks, the preferred stocks and retained earnings. Each of these components commands a certain percentage in financing the activities of the firms and when the analysis is done it amounts to defining the structure of the firm’s capital CITATION Har12 \l 1033 (Bierman, 2012). For Apix Printing Inc. the capital structure contains a majority of the financing coming from the owner’s ordinary equity at 0.6 and the debt at 0.4. This means that the firm’s debt to equity ratio is 0.6. This ratio of lower than one shows that the company is not highly leveraged and therefore safe from bankruptcy and able to have good liquidity issues. There is also a huge room for ratio debt finance since the structure has not reached leverage saturation which is achieved when the ratio is 1.
Importance of WACC to determine the feasibility of the capital project.
This weighted average cost of the capital sets out the minimum rate of return of any project or the rate at which the company projects must generate in order for the investors to make a return. It simply indicates the rate of return desired by the firm. The WACC rate is used as a discounting rate to for the calculation of the Net present values of the intended projects cash flows. The projected cash flows of the projects are discounted to help the management make an informed analysis of whether the projects are to have a positive or negative present values taking into account the time value of money. The WACC is also a representation of the risks, on the average, the firm is facing. It its adjusted from time to time to help analyze the projects. For a project that is of a higher risk than the firms average projects the WACC is reviewed upwards. If the firm is considering evaluation of projects that are less risky in comparison with the firm’s projects, a downward revision of the WACC is done CITATION Arv12 \l 1033 (Ghosh, 2012)
Recommendation
The recommended approach to apply the capital project evaluation is to use the determined company weighted average capital; cost as the discounting factors for the projected project cash flows or savings. The project will be worth investing if it is able to generate a positive net present value and unworthy for investment if the Net present values generated are negative. A less than zero net will mean that the project will eat i...