Mini Project Assignment Example | Topics and Well Written Essays - 500 words

Mini Project - Assignment Example The cost of debt refers to the effective rate in which a firm pays to use debt finance. The value is considered to be the proportion of interest on the entire debt value. However, this can be viewed in two approaches namely cost of debt before tax and cost of debt after tax. As such, cost of capital before tax will therefore refer to the effective rate an organization pays for it to use debt finance without incorporating tax while cost of debt after tax will refer to effective rate in which an organization will pay to use debt finance while considering tax. In relation to GE, the company pays 5.56% for its debt finance annually before tax. The value will translate to 5.35% cost of debt after tax. This implies that the proportion of interest on entire debt value before considering tax is 5.56% while the proportion of interest considering tax is 5.35%. Also, the measure of the cost of debt reflects the risk level of an organization when compared to others. Therefore, when a company rec ords a higher rate in its cost of debt than another, then it means investing in that company will be more risky. Therefore, a firm that has a cost of debt before tax greater than 5.56% and cost of debt after tax greater than 5.35% is more risky to invest in than GE. Cost of capital is another element that factors greatly in evaluating company performance. Cost of capital refers to the theoretical return an organization will pay for its equity finance as compensation for the risk they undertake in investing in that firm. Currently, GE has a cost of equity rate of 8.81%. The value is averaged by summing the risk free rate with measures of the reward for bearing systematic risk. Therefore, this implies that GE pays 8.81% annually over the long term as compensation to their equity finance providers. However, computing the rate using CAPM has some inherent flaws. The reason behind this view is that the approach uses S&P