Rate of Return

All suppliers of capital require a rate of return compared to the risk they take. This required rate of return is paid to capital suppliers. The suppliers of equity capital have a higher required rate of return because equity investors are paid after lenders (Gallagher, p. 238). The required rate of return is an after tax amount. Risk and return is a hard to understand relationship at times, but managers must know and address these concerns.

There is a methodical process in determining the required return. Management must decide the expected cash flows from the capital project. The firm has to also evaluate the riskiness of these cash flows. The firm then determines the cost of capital and how the cash flows will be discounted and then the required rate of return can be determined. An estimate of the assets value to the firm is determined. The project is then evaluated if it is acceptable or not. Many methods are used to determine if a project is acceptable or not. For example, the payback method, net present value, and internal rate of return. Simply put, the payback method is how many years will as it take for a firm to recover the original investment. The net present value method takes into account the time value of money by finding the value of yearly cash flows. The internal rate of return describes when the discount rate equates the present value of a projects expected costs compared to the present value or when the rate is guessed using a trial and error method and when the NPV is equal to zero, we have achieved our rate. Each method has advantages and disadvantages and managers must weigh these advantages and disadvantages.

If an internal rate of return exceeds the cost of the funds used to finance a capital proj...

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...rates different in China? WACC can be influenced by the market value and price per share in international investments.

When evaluating your desire to expand internationally into China, you must evaluate the taxes in China. You must differentiate how these taxes will affect the dividends to your share holders. When a corporation tries to bring the dollars back to the United States, these monies will be taxes as well.

Allowances have to be made for Capital Expenditures with no cash inflows.

The business risk must be evaluated. How will the uncertainty regarding the firm’s future affect future cash flows or earnings or required rate of returns.

References:Gallagher, Timothy J. (2009) Financial Management: Principles and Practice, 5th edition. Freeload Press. and Bringham, E. (1986). Fundamentals of Financial Management. New York,N.Y: The Dryden Press