Costs could rise.The article "Tax Relief--Chapter 2003" (JofA, Oct.03, page 41) doesn't mention the unfavorable impact that reducing dividend taxes is likely to have on corporate America's overall risk-adjusted cost of funds Cost of Funds The interest rate paid on an outstanding loan. Notes: Money isn't free! Cost of funds is the cost of borrowing money. See also: Interest Rate Cost of funds Interest rate associated with borrowing money. (that is, the weighted average cost of capital Weighted average cost of capital (WACC) Expected return on a portfolio of all a firm's securities. Used as a hurdle rate for capital investment. Often the weighted average of the cost of equity and the cost of debt The weights are determined by the relative proportions of equity ). The cost of capital for many companies will increase for the following reasons: First, since the cost of equity capital is typically several points higher than the cost of debt, increased returns to equity (higher aftertax dividends) will cause a greater portion of capital funding to shift to equity and thus raise the overall weighted average cost of capital. Second, although increased returns to equity will reduce the cost of equity capital, nothing happens in the capital markets in isolation. If returns to equity increase, returns to debt also will have to increase to remain competitive, all other things remaining equal. Corporate borrowing costs will jump and this will negatively affect earnings, thus somewhat offsetting the decrease in the cost of equity caused by reduced taxes. In summary, a higher cost of debt and a greater percentage of equity financing Equity Financing The act of raising money for company activities by selling common or preferred stock to individual or institutional investors. In return for the money paid, shareholders receive ownership interests in the corporation. will likely more than offset a net decrease in the cost of equity and thus result in a higher weighted average cost of capital for corporate America. Why is a higher cost of capital unfavorable? Most companies require investment projects to generate returns that meet or exceed the cost of capital rate. The higher the cost of capital, the fewer the projects that will be approved, thus causing a further slowdown in capital spending capital spending Spending for long-term assets such as factories, equipment, machinery, and buildings that permits the production of more goods and services in future years. , one of the major problems of our current sluggish economy Sluggish Economy A state in the economy in which the growth is slow, flat or declining. The term can refer to the economy as a whole or a component of the economy, such as weak housing starts. . Paul M. Green, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. Cincinnati |
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