Custom essay on China Essay found
China is a manufacturing superpower. Assume that you are CFO of an automobile manufacturer looking to build a $U.S.800 million plant in China. You are discussing this project with your spouse, who is intelligent, but has no background in finance.
1. Your discussion should begin with a clear and logical step-by-step explanation of the theory behind the concept of "required return" on proposed capital investments. Explain how cost of equity, cost of debt, WACC, and allowances for various risk factors are involved in determining the "required return" on proposed international capital investments.
Answer: Required return is a very important concept in finance. It tells us by what factor we need to discount the future cash flows that we will be receiving in the future. The higher the required return, the lower will be the present value of cash flows.
And generally higher return is required of risky investments. There are three components of required return. One is the cost of
equity or the cost of the company's stock, the other is the cost of debt or how cheaply can the company borrow money from the bank and the third is the cost of preferred stock. The weighted average cost of capital or WACC is the weighted average of these three different components. Again, we need to adjust the WACC depending on the riskiness of the project. If a project is riskier than normal projects, then we increase the WACC. If it is less risky, then we decrease the WACC. Thus, there is allowance for various risk factors in the WACC.
2. Discuss each of the main risk factors that should be allowed for in addition to WACC in order to determine the appropriate required return on this capital investment opportunity.