Cost of Capital

Topics: GlaxoSmithKline, Interest, Capital structure Pages: 24 (5336 words) Published: November 29, 2009
The long-term investments that make today will determine the value of business tomorrow. In order to make long-term investments in new product lines, new equipment and other assets, managers must know the cost of obtaining funds to acquire these assets. The cost associated with different sources of funds is called the cost of capital. . If the business earns more than its cost of capital, the market value of the business will increase. Likewise, if returns on long-term investments are below the cost of capital, market values will decline. Therefore, how we manage capital is extremely important to fulfilling the basic objective of increased shareholder value.

This report is basically concentrated on the topic of “Firm & Industry cost of capital”. And then there is an empirical analysis of cost of capital on pharmaceutical industry of Bangladesh by using the concept cost of capital & Statistical model. In Bangladesh the pharmaceutical sector is one of the most developed hi-tech sectors is contributing in the country's economy. There will be an extensive analysis on the pharmaceutical firm’s capital structure, their dividend payment pattern, their ROE in comparison with cost of equity and determining the factor that influencing the pharmaceutical company’s cost of capital largely.

Cost of capital is a very common phenomenon in a corporate world. It is essential to recognize whether the firm is maximizing its investor value or not. It is very hard to decide the required rate of return of investors of the company. For the purpose of determining the cost of capital of the firm and industry, Pharmaceutical industry has been chosen. This report will attempt to expose the following facts :

 Introducing Cost of Capital basics.  Capital structure and Dividend policy overview of the pharmaceutical companies.  The equity and assets beta of the pharmaceutical companies.  Industry Cost of capital the pharmaceutical sector of Bangladesh.  Whether pharmaceutical cost of capital influenced by capital structure and dividend policy or not.

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There is a cost of doing business that must serve as your benchmark for how you invest in long-term assets. This cost is called Cost of Capital. Cost of Capital is the rate you pay to those who lend or invest money into your business. You can think of Cost of Capital as the rate of return investors require for incurring risk whenever they give you money. Cost of Capital applies to long-term funding of assets as opposed to short-term funding of working capital. Why is Cost of Capital so important? Well, you have to earn an overall rate of return on your assets that is higher than your cost of capital. If not, you end-up destroying value. There are basically two forms of cost of capital identified in a firm. Such as:  Firm cost of capital: The cost of capital is the overall or average required rate of return on the aggregate of investment projects of the firm.  Project cost of capital: The project’s cost of capital is the minimum required rate of return on funds committed to the project. Project cost of capital may vary from firm cost of capital. Because the project's riskiness may differ from firm overall riskiness.

The cost of capital is influenced by a number of factors. Some are beyond the firm’s control, but others are influenced by its financing and investment policies. The graph is shown below, pasteurized that cost of capital of the determined by the combined influence of the firm’s Debt/Equity mix, Riskiness of the firm, Financial soundness of the firm and interest rate of the country. Here Debt/equity mix and financial soundness of the firm is under the firm control but the interest rate and the riskiness of the overall firm may change due to the changes of economic factors.

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Figure: Influencing factors of cost of capital

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