BUS 401 Week 5 Discussion 2 | ashford university
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- 27 Jul 2021
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BUS 401 Week 5 Discussion 2 | ashford university
Week 5 -
Discussion Forum 2
Your initial discussion thread is due on Day 3 (Thursday) and
you have until Day 7 (Monday) to respond to your classmates. Your grade will
reflect both the quality of your initial post and the depth of your responses.
Refer to the Discussion Forum Grading Rubric under the Settings icon above for
guidance on how your discussion will be evaluated.
Leverage and
Capital Structure [WLOs: 2, 3] [CLO: 3] |
“The use of debt to fund the firm (called leveraging) carries
with it benefits as well as risks” (Hickman et all., 2013, Chap 8, Overview,
para. 4). In the short term, leverage lowers the weighted average cost of
capital due to the typically lower required rates of return on debt as compared
to equity. In the long run, debt requires interest payments and the principal
must be repaid. A firm that cannot repay its debt faces default risk and/or
bankruptcy. The risks due to excessive leverage are known as financial risks.
Thus, as a firm considers using debt or equity to fund its business, it must
consider both the benefits of debt and the financial risks of too much debt. In
this discussion, you will evaluate a real-world scenario and consider the
implications of the debt financing decision for the firm.
Prepare:
Prior to beginning work on this discussion forum,
·
Complete the the Week 5 – Learning Activity: Understanding Cost of Capital.
·
Read Chapter 10
in Essentials of finance
·
Read Chapter 8:
Section 8.1: Perfect Capital Markets in Essentials of finance
·
Watch the following
video:
How Alex Clark Turned
$32,000 Into a Chocolate Phenomenon - 30 Under 30 | Forbes
After watching the video, answer the following questions in your
post:
·
Did Alex Clark
initially fund the business with equity or debt?
·
Initially, Clark’s
chocolate business is very small. Compared to publicly traded companies, would
Clark’s required rate of return on equity be higher or lower than the “average”
required rate of return on equity for small cap companies of 15%? Explain your
answer.
·
After the business was
established, Clark talked about buying a building to expand. This is a good
example of an investment project that a business must evaluate. Would the
required rate of return for Clark’s building purchase be higher or lower than
the overall chocolate company’s required rate of return? Explain your answer.
·
Should Clark use some
bank debt to finance all or a portion of the building purchase?
o Justify your answer by explaining how the
weighted average cost of capital for the company would change if Clark uses
bank debt to finance all or a portion of the building purchase.
·
What is the primary
risk that Clark faces if she uses debt to finance the entire building purchase?
For purposes of this discussion, assume that the debt would then comprise 95%
of the company’s capital structure.
Guided Response: Review several of your colleagues’ posts, and
reply to at least two of your peers by 11:59 p.m. on Day 7 of the week. In your
written responses to your classmates, address the following:
·
Provide feedback on
your peers’ answers, including whether you agree or disagree with any of the
answers or reasoning provided. Justify your opinion.
·
State your opinion on
whether Clark should use debt to finance the building purchase, and if so, how
much debt should be used (as a percent of the total building price). Justify
your opinion.