Cost of Capital
Jenny Lopez-Guerrero, Malika Hobheidar,
Phyllis Hebert and Sierra Harkness FIN571
February 23, 2015
Cost of Capital
In the Wiley plus simulation (2012), we are introduced to Pfizer, the world's largest research-based pharmaceutical company, Pfizer develops their own pharmaceutical products. Ahmed Singh, a consultant accountant who works for the Pfizer Treasury Department, explains that his role in the company is "to think and plan ahead for what should be the optimal plan structure for the company" (Wiley Plus, 2012). The Cost of Capital is the weighted average cost of debt and equity a company holds in its data base. The Cost of Capital is usually determined by the type of market a company is in, and it is meant to represent the degree of the risk perceived by investors. As one of the largest researched-based pharmaceutical companies in the world, Pfizer is considered a risky business because of the type of industry it is in. It is made clear on the video that Pfizer uses the Capital Asset Pricing model (CAPM), which helps calculate investment risks and the return on investment the company should expect. Pfizer capital base consists of broad mix of debt and equity. Over $40 billion in debt, and $8 billion share being traded. The net debt is the amount of debt that Pfizer holds in access of cash. The capital structure of the company is primarily equity. If the company could not sell drugs exclusively on the market, the company would not exist. Pfizer's Research and Development (R&D) is not funded project by project. The R&D is prioritized by the existing project in rank order of their value using financial metrics. How much return the company makes on the project depends on how much money they have invested into the project. In order to create the productivity index, which is the metric that is used for the evaluation of the project takes into account the value the project would...
References: Wiley plus. (2012). Concept review video: Cost of capital [Multimedia]. Retrieved from Wiley plus, FIN571 - Corporate Finance website.
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