Can i get a feedback for this discussion post below. Thank you You have just dis
ID: 2820255 • Letter: C
Question
Can i get a feedback for this discussion post below. Thank you
You have just discovered that your boss favors payback in evaluating investments. Should you try to talk him out of it or should you go along with his/her desires?
Well I believe it all depends on the boss/company. If it was up to me depending on if the company cash flow was doing well, I wouldn’t really have a desire for evaluating the payback on an investment, I would rather be interested on whether or not It will make me the most money. However, if cashflows were low and the company was in dire need for a payback on its investment then by all means, I would recommend him to evaluate the payback on investments.
Young companies usually finance their assets with equity. Why?
Equity is the investment money that is given from investors/owners of the company to the company. Equity is a great alternative in receiving money versus debt. It allows these young companies to get off their feet and have enough founds to operate and expand. Companies are not obligated to obligation to pay back the money received by investor. Investors are looking to make money of their investments through their returns. There is no required payments or interest charges. It is a real incentive for young companies to seek investors in order to be more successful and more competitive in the industry.
Maverick, J. (2015, April 22). What are the benefits for a company using equity financing vs. debt
financing? Retrieved September 20, 2018, from
https://www.investopedia.com/ask/answers/042215/what-are-benefits-company-using-equity-
financing-vs-debt-financing.asp
Equity financing can come from external or internal sources. Which of these is the least expensive and why?
Both these financing strategies are a great way for a firm to gain capital. External equity financing includes common stock and long-term bonds investments. Internal equity finance involves reinvesting earnings back into the company. So instead of giving the stockholders back some money they put that money back into the company to grow. Internal equity is the least expensive. Internal equity financing avoids flotation costs and adverse signals.
Ehrhardt & Brigham (2017). Corporate Finance (6th Edition). South-Western
Explanation / Answer
Answer to first question and second question can be enhanced by including following information in the discussion, while third question involves a minor correction.
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Part A)
Payback method determines the period within which the initial investment is recovered by the company with the use of cash inflows generated by the project. While this method is simple to implement, it has some serious flaws which are given below:
1) Payback method doesn't take into account the time value of money. This limitation can, however, be overcome with the use of discounted payback method.
2) Payback method ignores the cash flows that occur after the payback period. As a result, this method cannot be considered reliable.
The best capital budgeting method for evaluating investments is Net Present Value (NPV) which is the difference between the present value of cash inflows and cash outflows. If NPV is positive, the company can accept the project and vice versa. It can be used for both short-term and long term projects.
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Part B)
Young companies usually finance their assets with equity because it is difficult for them to obtain finance/loans through third party sources such as banks and financial institutions. Therefore, such companies are forced to use their own money/capital or borrow money from relatives/friends. When owners invest money in the company, it becomes equity. With the passage of time, as the company grows, it might be able to obtain funding from external sources based on their financial performance over the years or sell equity to outside investors for obtaining capital.
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Part C)
External equity financing involves raising capital through issue/sale of equity to general public or institutional investors. It doesn't include long-term bonds investments. Certainly, internal equity financing is least expensive as it involves no flotation costs. Further, external shareholders expect return on their investments (either in the form of dividends or capital appreciation of their holdings in the company). With the use of internal equity, the company can avoid external factors affecting the business operations and decision making processes (of the company).