The issue of corporate financing decisions and capital structure has become extremely important taking into account the recent dramatic changes in the economy. Companies must constantly review their hybrid securities, equity and debt in order to finance operations, assets and their future growth. The American Recovery and Reinvestment Act of 2009 was ratified as a response to the economic crisis for stimulating the development of economy. This paper is aimed at making the financing and investment decisions, concerning the position of business, and identifying benefits of the Act. It looks at several situations when deciding on the capital cost, additional cash instead of investment and debt for a new project from the financial perspective.
The Cost of Capital
Cash position is an indication of financial liquidity, stability and strength. Therefore, the improved cash position of company shows that financial responsibilities can be fulfilled. Progressive management constantly pays attention to the cost of capital when making financial decisions. Obviously, the company should choose a project, which would be no less than the capital costs involved in its financing, thus giving an adequate return on investment. Moreover, the fluctuations of capital market must also be taken into consideration in order to achieve the economic and sound capital structure. Various finance methods can be applied to minimizing the capital cost with the purpose to increase the earnings per share and market price. In addition, the interest rate on loans as well as the regular dividend rate on the market ought to be analyzed. Even though the capital cost is a significant factor in making such kinds of decisions, control and the prevention of risks are equally important.
The Decision on Investment
As a financial consultant, one can show a value that the client can add while making the proper decision, i.e. putting his/her additional cash to better use than the present investment. This can be done by reducing risks, showing the real design and actual documentation, etc. Besides, there is a need to discuss the consequences of what will happen if the client follows the advisor’s recommendations and guidance, such as better outcome. The consultant can assist the client in avoiding such an emotion-based mistake and think logically, using the CORE (confidence, objectivity, reliability and empathy) method. It helps clienteles control their feelings in the financial situation. Confidence can convince the client that his/her consultant has the necessary skills for coping with the emotional factors that may influence the choice in the future. Confidence can be shown via other parts of the proposed method. Objectivity enables the adviser remain empathic, understanding and pleasant while reliability demonstrates that he/she is able to comply with the obligations, maintain the integrity of each interaction and put the interests of client first. What is more, the consultant should have empathy for the existing emotional reaction of a client, which means the experience of understanding people’s actions and looking from their perspectives.
Levered and Unlevered Equity
Unlevered equity refers the company’s capital with no debt. Hence, the capital cost is simply the cost of equity while a levered company has debt in its capital structure. The difference between the capital cost and risk of levered equity and return of unlevered equity can be considerable as debt is more costly for the company to issue than the equity. It creates economic benefits for those, which raise capital without recourse to debt market.
If the firm borrows a significant amount of money, the ratio of debt to equity will grow. In this case, the likelihood that the company will not be able to meet its financial commitments increases, as well. Furthermore, financial distress can occur when the credit risk is high. It leads to higher interest rates, lost sales and profits. Eventually, it results in the incapability to invest in cost-effective projects since the external funding sources become unobtainable. In the case of possible default, a levered firm’s value is lowered by the present value of expected bankruptcy costs. Consequently, the risk of company increases with the growing level of debt. Investors usually expect higher returns to compensate for the increased risk. Thus, the unlevered capital cost will become a cheaper alternative to the levered capital cost. Therefore, there are higher costs related to the issuance of debt or preferred equity.
The American Recovery and Reinvestment Act and Its Contribution
The Act’s main objectives were to preserve the existing jobs and create new ones, drive the economic growth and long-term investments, and ensure transparency and accountability in public spending. The law is based on Keynesian macroeconomic theory, which recommends reducing private spending and increasing government spending in order to save working places when the economy is deteriorating.
Given the American Recovery and Reinvestment Act of 2009, some funding is directed toward the most vulnerable segments of the population: low-income earners, retirees and unemployed workers. These people are given money in the form of unemployment benefits or grants. With regard to business, suppliers and manufacturers can receive about $115 billion by direct government aid, mainly related to infrastructure. The funds are used for the development of healthcare, transportation, education, technology and energy, water and environment.
These funds are usually distributed quickly across the states to all deserving persons for preventing layoffs, improving student achievement and creating more employment opportunities. The states are required to have mechanisms for the rapid distribution of their allocated funds in order to help restore the economy. The funds are used to promote academic improvement among students regardless of their origin. This principle tracks progress in schools and ensures all students, including those with disabilities, that they have equal access to education. It guarantees that the qualified educators will teach all the learners, particularly those with special needs. Finally, the principle provides intensive support for the poor performing schools. The Act makes the emphasis on stopping fraud and abuse of funds. The recipients of funds are obligated to report on their use. In accordance with the American Recovery and Reinvestment Act, funding must be thoughtful to avoid instability.
It should be noted that the tax benefits are part of the Act. Therefore, it will raise taxes in the future.
The lessons show that economic problems cannot be easily resolved. However, the American Recovery and Reinvestment Act of 2009 became a first step to the economic recovery, thus going in the right direction. According to it, a balance must be attained through proper investments, accountability and transparency. As for financial decisions, the past experience needs to be studied; the current economic conditions, behavior and practice of the firm have to be taken into account, as well. In connection with the recent financial crisis, the recommendations presented in the paper are vital for the survival of business today. In order to ensure long-term economic improvement, there is a need for the distribution strategy that balances investments and economics. It is also essential for firms to understand how to invest, borrow and decide on capital costs and structure, using their funds wisely. The last recommendation is that more funds have to be allocated to the employment program, but business should not suffer.