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Question

Question:

1.      Using the notes for Seminar 6 that are on Moodle in the Topic 6 area, explain briefly the two types of capital that are included in the WACC (Weighted Average Cost of Capital).

2.      I want to start my own food delivery business. I can purchase at push bike for $300 or a motor scooter for $1000.

a.      What are two (2) factors that I should consider when deciding which to purchase and briefly explain why they are important?

b.     The WACC for the push bike is 3%. The WACC for the motor scooter is 9%. If my expected return in operating the business is 7%, what should I do?

Answer 1

1) The two types of capital included in the WACC are the cost of debt and the cost of equity. A company can use these two sources of capital financing The cost of debt is the interest rate a company pays to its debtholders. The cost of equity is the return required by shareholders.

2A) Two factors to consider when deciding which to purchase would be the cost of capital for both, as well as the expected life of the asset. The cost of capital refers to how much it costs to use that source of financing. If it costs more than the expected return, the purchase would cause you to lose money. The life of the asset is also important because even though one may be a cheaper option, it may actually cost more in the long run if it needs to be replaced more frequently.

2B) The cost of capital is 3% for the push bike and 9% for the motor scooter. This means it would cost you 3% to purchase the push bike and 9% to purchase the motor scooter. Since you expect a return of only 7%, the motor scooter would cost more than you expect to earn. You would choose the push bike because it costs less than the 7% expected return.