The Cost of Capital

The Cost of Capital

Cash Conversion Cycle (CCC) = Operating Cycle (OC) - Payables Deferral Period

Kroger’s operating cycle and cash conversion cycle are reasonable. They can reduce the operating cycle by improving the inventory turnover.

Cost of capital
The cost of capital is the required rate of return that a firm must achieve in order to cover the cost of generating funds in the marketplace. Another way to think of the cost of capital is as the opportunity cost of funds, since this represents the opportunity cost for investing in assets with the same risk as the firm. When investors are shopping for places in which to invest their funds, they have an opportunity cost. The firm, given its riskiness, must strive to earn the investor’s opportunity cost. If the firm does not achieve the return investors expect (i.e. the investor’s opportunity cost), investors will not invest in the firm’s debt and equity. As a result, the firm’s value (both their debt and equity) will decline.
The WACC is the weighted average of the cost of equity and the cost of debt based on the proportion of debt and equity in the company's capital structure. Following assumptions are important:
The estimation of the WACC is based on several key assumptions:

• It is market driven. It is the expected rate of return that the market requires to commit capital to an investment.
• It is a function of the investment, not the investor.
• It is forward looking, based on expected returns.
• The base against which the WACC is measured is market value, not book value.
• It is usually measured in nominal terms, which includes expected inflation.
• It is the link, called a discount rate, which equates expected future returns for the life of the investment with the present value of the investment at a given date.

Some additional things to consider:
• Increase in cost of capital because externally raised capital can have large flotation costs, which increase the cost of capital.
• Investors often...

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