Financial Management
Answer Sheet:
1. What is the importance of cost of capital in Financial Decisions? Explain. The term “cost of capital” is defined as a the rate of return on investment projects nesscery to have unchanged market price of a firm’s share. It may be the rate at which funds can be borrowed on new equity capital or, it may be the rate at which futher cash flows are discounted to measure its present values. The cost of Capital of a firm is the weighted average of the cost of the various sources of finance that have been used by it. The cost of capital to a firm is the minimum rate of return that it must earn on its investments in order to satisfy the various catagories of investors who have made investments in the form of shares, debentures or term loans. Unless they company earns this minimum rate, the investors will be tempted to pull of the company. The optimum cost of capital is the financial break-even point. It represents a minimum rate of return. If the risk is involved, the minimum rate of returns should be higher in order to cover the business risk as well as the financial risk. Importance of cost of capital in Financial Decision refers to the concept of cost of capital is a very important concept in financial management decision making. The concept, is however, a recent development and has relevance in almost every financial decision making but prior to that development, the problem was ignored or by-passed. The progressive management always takes notice of the cost of capital while taking a financial decision. The concept is quite relevant in the following managerial decisions. That are:
• Capital Budgeting Decision
• Designing the Corporate Financial Structure
• Deciding about the Method of Financing
• Performance of Top Management
• Other Areas
➢ Capital Budgeting Decision:- Cost of capital may be used as the measuring road for adopting an investment proposal. The firm, naturally,
1. What is the importance of cost of capital in Financial Decisions? Explain. The term “cost of capital” is defined as a the rate of return on investment projects nesscery to have unchanged market price of a firm’s share. It may be the rate at which funds can be borrowed on new equity capital or, it may be the rate at which futher cash flows are discounted to measure its present values. The cost of Capital of a firm is the weighted average of the cost of the various sources of finance that have been used by it. The cost of capital to a firm is the minimum rate of return that it must earn on its investments in order to satisfy the various catagories of investors who have made investments in the form of shares, debentures or term loans. Unless they company earns this minimum rate, the investors will be tempted to pull of the company. The optimum cost of capital is the financial break-even point. It represents a minimum rate of return. If the risk is involved, the minimum rate of returns should be higher in order to cover the business risk as well as the financial risk. Importance of cost of capital in Financial Decision refers to the concept of cost of capital is a very important concept in financial management decision making. The concept, is however, a recent development and has relevance in almost every financial decision making but prior to that development, the problem was ignored or by-passed. The progressive management always takes notice of the cost of capital while taking a financial decision. The concept is quite relevant in the following managerial decisions. That are:
• Capital Budgeting Decision
• Designing the Corporate Financial Structure
• Deciding about the Method of Financing
• Performance of Top Management
• Other Areas
➢ Capital Budgeting Decision:- Cost of capital may be used as the measuring road for adopting an investment proposal. The firm, naturally,