The Risk Inherent in Project of Harriet-Free-Samples for Students

Questions: 1.Provides a thorough and detailed explanation of his/her reaction to Harriet's suggestion, evaluating Harriet's idea and providing a strong rationale for his/her position. 2.Provides a thorough and detailed evaluation analyzing whether or not capital projects should have their own unique cost of capital rates for budgeting purposes, including a strong rationale for conclusions drawn, evaluating the relatively high risk inherent in Harriet's project, and recommending whether or not it should be budgeted at higher risk. 3.Student provides a thorough and detailed explanation of how he/she would factor the notion of risk into the analysis so that all competing projects that have relatively lower or higher risks can be evaluated on a level playing field. Student provides strong rationale for his or her approach to factoring in risk for such purposes. Answers: 1.The issue put forward in the question is that if a particular project is financed with the help of retained earnings and bonds will that be useful for the firm or not. In order to justify this statement at first the meaning of retained earnings must be understood. Retained earnings refer to the earnings that are kept aside as a reserve of cash with the main purpose of growing further business in the future. In simple terms retained earnings are nothing but profits or revenues kept aside by the company for further expansion or emergency purposes. Retained earnings can also be used for financing the day to day operations of the business. Now the paradox lies in the fact that investment if done with the help of retained earnings then the case becomes such that revenue is used for incurring more revenue or loss. Thus undertaking risk on the basis of already earned revenue has certain advantages and disadvantages (Brigham Houston, 2016). The advantage of financing projects with retaine d earnings is that the owner or the core management of the company is in total control of the situation, that is no involvement from any kind of third party has to be tolerated by the management in the matter of utilizing the retained earnings in the business. Using the retained earnings does not really add to the profile of debt and also no extra interest payments have to be done on the profits. Businesses using capital other than retained earnings are burdened with decisions from creditors or new partners or investors in such a way that the entire decision making process become an issue in itself. But companies using retained earnings enable them to keep away the unnecessary judgments or decisions from hampering the entire process (Shim, 2013). However there are also certain disadvantages that are related with the utilization of retained earnings. The first disadvantage is that the entire process of financing becomes slow. This is because in the procedure of collecting or retaining enough funds the chances to grab new business opportunities might be missed. Retained earnings are also used in the course of daily operations thus too much usage of retained earnings for the purpose of further expansion may undermine the purpose related to daily operation funding. Contrary to the above presented opinion, inclusion of new partners or investors in business may open brand new ways to business that might be very helpful for the business to prosper and grow (Atherton, 2012). Harriet though is of the opinion that retained earnings must be used so that the projected return is more but the conditions required to execute such a proposal should be checked by the management and then the final decision should be taken (De Mooij, 2012). 2.The issue presented in the question is that whether capital projects should have unique cost of capital rates for budgeting purposes or not. Capital projects should have unique cost of capital rates for budgeting purposes because this helps in assessing the economic sense of a particular project. In more simple terms the discounted net present value should be more than the expected costs of financing, then only a project is undertaken(Brigham Houston, 2016). The risk related to a particular project must be assessed as because projects with high risk have to have a higher percentage of discount than the historical weighted average cost of capital of the company. A unique rate of cost of capital enables a company to calculate the cost of capital accurately so that the net present value can be assessed properly (Humphrey, 2014). The risk inherent in Harriets project is high and should be budgeted at higher risk because when the retained earnings are used, the after tax cost of debt is reduced to 7% and as a result the weighted average cost of capital would come down to 3.5% thus the 10% projected return would be great (Godley Lavoie, 2016). 3.The issue presented in this particular question is that how the projects with higher or lower risks can be evaluated on a level playing field. This can be done by finding out the net present value of the project that should be more than the cost of capital related to that particular project. The different accounting methods used for this purpose are internal rate of return, accounting rate of return and pay-back period (Brigham Houston, 2016) References Atherton, A. (2012). Cases of start-up financing: An analysis of new venture capitalisation structures and patterns. International Journal of Entrepreneurial Behavior Research, 18(1), 28-47. Brigham, E. F., Houston, J. F. (2016). Fundamentals of financial management. Cengage Learning.( Chapter 10 pp. 340-360) De Mooij, R. A. (2012). Tax biases to debt finance: Assessing the problem, finding solutions. Fiscal Studies, 33(4), 489-512. Godley, W., Lavoie, M. (2016). Monetary economics: an integrated approach to credit, money, income, production and wealth. Springer. Humphrey, C. (2014). The politics of loan pricing in multilateral development banks. Review of International Political Economy, 21(3), 611-639. Shim, J. (2013). Bank capital buffer and portfolio risk: The influence of business cycle and revenue diversification. Journal of Banking Finance, 37(3), 761-772.