Discuss how Change in Interest Rates can mitigate those risks and develop a strategy for minimizing the WACC.

Change in Interest RatesUsing the example of an actual company, explain how a change in interest rates in the economy affected each component of the weighted average cost of capital. Describe how this company can mitigate those risks and develop a strategy for minimizing the WACC.Use the terminology and concepts introduced in corporate Finance One page paper should be at least 200-250 words in length and must use at least two resources as support, including the course textbook (Ehrhardt, M. C., & Brigham, E. F. (2011). Corporate finance: A focused approach. South-Western Cengage Learning.), and can also include other professional/academic literature, or web-based articles.

Answer & Explanation

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Interest rates play a significant role in determining the cost of capital for a company, which is reflected in its weighted average cost of capital (WACC). WACC is the average cost of all sources of financing used by a company, including debt and equity. When interest rates increase, the cost of borrowing money also increases, which can lead to a higher WACC for a company. Conversely, when interest rates decrease, the cost of borrowing money decreases, which can lead to a lower WACC.

One way in which a change in interest rates can mitigate risk is by reducing the cost of debt financing for a company. For example, if interest rates decrease, a company can refinance its existing debt at a lower interest rate, which will reduce the cost of debt financing and, in turn, lower the company’s WACC. This can help to mitigate the risk of higher financing costs and make the company more financially stable.

Another way in which a change in interest rates can mitigate risk is by increasing the demand for equ

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Step-by-step explanation

ity financing. When interest rates are low, investors are more likely to invest in equity because they are not receiving high returns on their fixed-income investments. This can increase the demand for equity financing and make it easier for a company to raise capital through the issuance of new equity. This can also help to lower the company’s WACC and mitigate the risk of high financing costs.

To develop a strategy for minimizing the WACC, a company can consider the following:

Optimize capital structure: The company can optimize its capital structure by balancing debt and equity financing to achieve the lowest possible WACC. This involves finding the right mix of debt and equity financing that maximizes the benefits of both while minimizing the costs.

Monitor interest rates: The company should monitor interest rates and adjust its financing strategy accordingly. If interest rates are expected to rise, the company can consider refinancing its debt or issuing more equity to reduce its WACC.

Manage risk: The company can manage risk by diversifying its financing sources and not relying too heavily on any one source of financing. This can help to reduce the overall risk of financing costs increasing.

Improve credit rating: The company can improve its credit rating, which can lower its cost of debt financing. This can be achieved by maintaining a strong financial position, improving profitability, and reducing debt levels.

Evaluate projects: The company can evaluate projects based on their expected return on investment (ROI) and their impact on the WACC. Projects with a higher ROI that also lower the WACC should be prioritized over projects with a lower ROI that do not have a significant impact on the WACC.

In summary, a change in interest rates can have a significant impact on a company’s WACC, and by monitoring interest rates and optimizing its capital structure, a company can mitigate the risk of higher financing costs and develop a strategy for minimizing the WACC.

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