Capital Structure and Budgeting

Posted: August 27th, 2021

Capital Structure and Budgeting

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Institutional Affiliation

Capital Structure and Budgeting

Question 1

Sarbanes-Oxley Act of 2002 is a public corporation accounting reform whose chief goal entails offering investors with protection against fraudulent auditing activities. Specifically, this enactment requires public companies to have regular auditing concerning the corporations’ full and official names. Moreover, the Act mandated the executive managers of public companies to comply with adequate financial controls. The Act is considered significant as it seeks corporate excellence via the compliance of healthy financial reporting and internal controls. Therefore, it promotes corporate management responsibility, discipline, and transparency, leading to increased confidence and appreciation among investors.

Question 2

First, the Net Present Value (NPV) has a clear decision rule coupled with significant time value of money, thus increasing shareholders’ wealth optimally. On the contrary, the NPV method has a weakness in forecasting the future streams of cash flows due to the difficulty of estimating the discounting rate (Rossi, 2015). Second, the IRR method offers a clear decision rule as it compares the rates of return from other investments easily. Moreover, by involving the time value of money and the project’s initial costs, the stakeholders can easily understand this method’s concept. However, the IRR method has a calculation weakness without using a financial calculator, as there are both negative and positive cash flows. Next, with the simplicity of the payback method to estimate gains’ value, it offers a clear decision rule on the payback period (Rossi, 2015). Therefore, by presuming the time value of money, the method fails to incorporate the cash flows for particular periods. 

Question 3

Since capital structure entails both debt and equity; therefore, leverage is a form of debt financing that defines a company’s capital structure. Likewise, leverage as a form of debt financing is pegged on a risk value as it may imply either a profit or loss. For example, company A has a debt and equity financing of $8 million and $2 million, respectively, and can enter a $1,000 trading capital, hence losing $10,000 as trading capital.

References

Rossi, Matteo. (, 2015). “The use of capital budgeting technique.” International Journal of Management Practices, 8(1), 121-212.