The dream of every business man or organization is to see their business sustain itself and expand their operations in order to realize higher profits. Investors need to carry out periodic assessments to evaluate the rate of returns on their investments. There is the need to evaluate business performance whether the business is on track according to its mission, vision and objectives.
To achieve these goals is not an easy task especially in the modern world that is full of competitions from similar investments and challenges of inflation and insecurity (Sherman 2012). This essay analyzes the circumstances of evaluating a firm’s new investment proposal with marginal and historic costs of capitals.
Marginal cost of capital refers to the expense incurred while adding an extra dollar to the capital of the business. It is the cost of raising additional funds to finance various business projects in order to increase its production and sales. Security on the capital secured plays a vital role in regulating the value of marginal cost of capital.
Unsecured loans are usually expensive since the business has to meet the higher rates offered by various business institutions that offer to entice investors seeking additional capital (Baptiste 2012). Secondly, when an investor has collateral security like bonds; it is particularly necessary that the investor uses the bonds as security for securing additional capital.
Thirdly, an investor should avoid acquiring insubordinate debts since they are expensive to finance. Lastly, investors should give priorities to debts that require collateral securities than those that have high interest rates in order to cut down the expenses incurred.
Historic cost of capital refers to the initial cost of assets at the time of acquisition by a business. The balance sheet reflects these values well by showing the price of all items at the time of opening the business. Historic cost of capital comes to use when the item under evaluation does not have a high rate of depreciation or appreciation (Berkery 2007). It is necessary to consider this point since assets like land appreciate at a higher rate than buildings due to their demand on the market.
On the other hand, machines, vehicles and furniture depreciate due to wear and tear actions. This method of evaluating an investment proposal is suitable if there is a small gap between the period of acquiring the asset and the time of preparing the proposal.
Similarly, assets that do not have a high value on the market do not have high appreciation or depreciation rates and this makes their value be constant for a long time. Their acquisition value can be used in any proposal without causing considerable difficulties in implementing the project.
Foreign currencies also determine the suitability of historic cost of capital. Some business assets come from foreign countries, and this means that foreign exchange must be involved in the process (Belcher 2011). In most cases, foreign exchange rates fluctuate depending on various factors like inflation, rate of foreign investments and security.
Given the current economic climate, it is advisable for any investor seeking additional capital to use both approaches to raise additional funds for the business since there is no single approach that is cost free. All approaches discussed above have positive and negative aspects that determine their suitability. However, the marginal cost of capital seems to be a better idea compared to historic cost.
Baptiste, J. (2012). The Ultralight Startup: Launching a Business without Clout or Capital. New York; Portfolio Media Publishers.
Belcher, P. (2011). Money to Start a Business: How to raise all the Money You’ll Ever Need to Start Your Own Business. Connecticut: Shoestring Press.
Berkery, D. (2007). Raising Venture Capital for the Serious Entrepreneur. New York: McGraw-Hill.
Sherman, A. (2012). Raising Capital: Get the Money You Need to Grow Your Business. New York: Amacom Publishers.