How can the WMCC (Weighted Marginal Cost of Capital) schedule and the
IOS (Investment Opportunities Schedule) be used to find the level of
financing/investment that maximizes owner wealth?
Why do many firms finance/invest at a level below this optimum? Explain.
Why do many firms finance/invest at a level below this optimum? Explain.
It is used to show how much money you can use to investment decisions. You can invest money until your WMCC=IOS. If your IOS is greater than your WMCC then you have made a bad investment decisions because you went over your average capital. Company tend to invest below because it brings in more wealth to shareholders. You don't really want it to be even because your company really won't make monetary growth.
ReplyDeleteThat is true Donbirdman! A company shouldn't want to be even because they really won't make any investment growth.
DeleteDon,
DeleteGlad you brought up this point. Most owners stop investing before the marginal return from investment equals its WMCC. The majority of owners prefer the position below the optimal investment budget, which is also called the optimal capital budget.
I agree with your answer because if on your graph the WMCC is above the IOS you will be charged more interest on the borrowed money. If you are at the point on the graph where they both meet you are receiving the most profit
Deletethis is a very good explanation. it explains the ins and outs of the process and why its done.
DeleteMost firms are afraid of losing their money to crazy investments, most of the time they don't know that the company will either lose net income or gain from their investments.
DeleteThe weight actually depends on how much assets a firm has put into different sources which in turn management should be able to determine the combined cost of funds from each source to maximize the value of the owners investment
ReplyDeleteThe more assets a company has put in different sources it can be able to determine the combined cost of funds from each source to get maximal value in the investment.
DeleteWhen you combine the weighted marginal cost of capital (WMCC) schedule and investment opportunities schedule (IOS), you can use it to make investment decisions. The rule is to invest in projects up to the point on the graph where marginal return from investment equals its WMCC (where IOS=WMCC) Look here for more information.http://blogbschool.com/tag/weighted-average-cost-of-capital/
ReplyDeletethe weighted marginal cost of capital (WMCC) schedule and investment opportunities schedule (IOS), we can use it to make investment decisions.
DeleteYou're right about combining the weighted marginal cost of capital schedule and investment opportunities schedule to make investment decisions, but also remember that these decisions also depend on the company itself because all companies are different according to their productivity rate.
DeleteMajority of business owners should use these methods due to the fact of them being more organized, and also having things done the way they want them to be done. It's very important to make sure that if you're a business owner that you have all of your bills up to date. Without the right usage of the money you profit from the business, you probably wouldn't be open that long, organization and responsibility is everything in being an owner. Most of the time business owners invest at low level due to the fact of them being aware of the risks that each company has depending on the field or the service they're providing.
ReplyDelete
DeleteMyron,
The IOS is graphical depiction of a company’s investment opportunities and expected return in order from highest to lowest . A company’s optimal capital budget is found where the investment opportunity schedule intersects with the company’s WMCC.
Business owners should be aware of the risk that they are taking when making investment decisions. If you own your own business the turning a profit immediately you may want to hire an accountant.
DeleteThe successful use of financial leverage increases the return on the owner's equity and increases earnings. The weighted marginal cost of capital is the sum of the weighted marginal cost of each form of capital. In addition to being the cost of additional sources of finance, WMCC shows the relationship between the level of total new financing and a company’s weighted average cost of capital.
ReplyDeleteAn IOS is a graph where the business’s investment opportunities are ranked based on their returns and financing required, from highest to lowest. Both the WMCC and IOS can be used to make investment decisions. The majority of firms or owners stop investing before the marginal return from investment equals its WMCC. Ideally IOS should equal WMCC.
***Correction: Ideally you want your project to be on the left of the point where IOS=WMCC. This will maximize wealth.
DeleteYou're right bro investments are based off of the firms returns but the company as a whole still have to document and pay attention to their debts and the investments that are current meaning the current transactions.
DeleteWhen the internal rate of return is greater than the weighted marginal cost of new financing., the firm should accept the project. the return will decrease with the acceptance of more projects, and the weighted marginal cost of capital will increase because greater amounts of financing will be required . The decision rule therefore would be: Accept projects up to the point at which the marginal return on an investment equals its weighted marginal cost of capital.
ReplyDeleteit is important to note that the majority of firms stop investing before the marginal return from investment equals its weighted marginal cost of capital (WMCC).
DeleteWhen making an important investment decisions that involves a lot of money it is very important to used the Weighted Marginal cost of Capital and Investment Opportunity Investment schedules. Because by doing so it shows the relationship between the two how much it help you save in the long run. And how you will manage your money better in the future.
ReplyDeleteI agree using the weighted marginal cost helps
DeleteThe manager must first know all the component costs. This helps with the determination of what investment to get involved in and how much the will need to finance or invest in the project to maximize owner wealth. This also allows the manager to know how much of retained earning they can offer for new common stock and at what price. This cost is relevant to current decisions. This increases as total levels of financing increases. It calculates the breaking point as to how much a firm will have to raise before increasing financing.
ReplyDelete- Many firms will operate on optimum level because it allows them to increase if need in the future for additional investments. They do not want to max out their financing on one investment.
this is a very good answer. managers need to asses these things in order to be successful
DeleteI agree the component costs is very important because it help you make the best decision for the company,allows you to have more money saving up and later on able to uses wisely on important things
DeleteYes, this allows them to show investors the risk involved in their investment. It also helps with how much interest they will have on a loan. It an organization is using more capital than equity they should have low interest rates on additional investments.
ReplyDeleteYes, the chart shows if a business move is profitable or not.
DeleteI concur...the chart displays if its profitable or not
DeleteAnd without investment growth it becomes difficult to obtain new investors and pricing of stock will eventually begin to fall.
ReplyDeleteWhen a company is making an important investment decision that requires or involves a big amount of money to be invested it is very important to use the Weighted Marginal cost of Capital and Investment Opportunity Investment schedules. this helps the company make smart decisions based on strategic planning according to the costs. it allows risk factors to be identified along with many other things.
ReplyDeleteZiggy definitely true when making an important decision company need to know their option first before involves themselves in any decisions that will impact them in a bad way
Deleteconstruct the investment opportunities schedule (IOS), which is a graph where the business’s investment opportunities are ranked based on their returns and financing required, arranged from the highest returns and all the way to the lowest returns. It is the decreasing function of the level of total financing.
ReplyDeleteIf we combine the weighted marginal cost of capital (WMCC) schedule and investment opportunities schedule (IOS), we can use it to make investment decisions. The rule is to invest in projects up to the point on the graph where marginal return from investment equals its WMCC (where IOS=WMCC).
Many businesses use marginal cost calculations to decide whether it makes sense to raise capital by borrowing funds or wait. If the cost of borrowing exceeds its return, it often makes no sense to borrow.
DeleteI agree borrowing makes no sense at all
DeleteBy determining the weighted average cost of capital at various increments of financing, a list of investment opportunities become available to the company. It shows an internal rate of return ranking of capital projects from best to worst. It also provide a set of decision criteria for determining the acceptability of capital projects. However, even if the proportion of debt to equity is maintained, the marginal cost of capital may increase as the company has to pay flotation costs and issue riskier debt with a higher interest rate to raise additional funds. This is why companies finance/invest at a level below this optimum.
ReplyDeletethe WCC and IOS are used to determine whether or not to invest by raising capital. depending on the company investing when levels are under the optimal capital structure is best.
ReplyDeleteThe reason it is best to invest below optimum is because it would make no sense to borrow/finance/invest if the return isnt greater.l