Cost of Capital
Cost of Capital
Definition: cost of capital is the rate of return that a company must earn on its project investments to maintain its market value and attract funds. The cost of capital to a company is the minimum rate of return that is must earn on its investments in order to satisfy the various categories of investors, who have made investments in the form of shares , debentures and loans. The cost of capital in operational terms refers to the discount rate that would be used in determining the present value of the estimated future cash proceeds and eventually deciding whether the project is worth undertaking or not. It is defined as "the minimum rate of return" that a firm must earn on its investment for the market value of the firm to remain unchanged.
Basic Aspects of concept of Cost of capital : here are three basic aspects of concept of cost. They are: * It is not a cost as such. * It is the minimum rate of return. * It comprises the following 3 components:
* Return at Zero risk level – This refers to the expected rate of return when a project involves no risk whether business or financial. * Premium for business risk – The term business risk refers to the variability in operating profit due to change in sales. The concept is higher the risk, higher is the expected return. * Premium for financial risk – The term financial risk refers to the risk on account of pattern of capital structure. In general, it can be said that a firm having higher debt content in its capital structure is more risky as compared to a firm which has comparatively low debt content.
Importance of Cost of capital: * It is relevant in the field of managerial decision as this dynamic concept is affected by a company’s capital structure, its’ financing plans for the future and any changes in the rate of earnings. * When taking decisions based on Net Present Value method, the cost of
Definition: cost of capital is the rate of return that a company must earn on its project investments to maintain its market value and attract funds. The cost of capital to a company is the minimum rate of return that is must earn on its investments in order to satisfy the various categories of investors, who have made investments in the form of shares , debentures and loans. The cost of capital in operational terms refers to the discount rate that would be used in determining the present value of the estimated future cash proceeds and eventually deciding whether the project is worth undertaking or not. It is defined as "the minimum rate of return" that a firm must earn on its investment for the market value of the firm to remain unchanged.
Basic Aspects of concept of Cost of capital : here are three basic aspects of concept of cost. They are: * It is not a cost as such. * It is the minimum rate of return. * It comprises the following 3 components:
* Return at Zero risk level – This refers to the expected rate of return when a project involves no risk whether business or financial. * Premium for business risk – The term business risk refers to the variability in operating profit due to change in sales. The concept is higher the risk, higher is the expected return. * Premium for financial risk – The term financial risk refers to the risk on account of pattern of capital structure. In general, it can be said that a firm having higher debt content in its capital structure is more risky as compared to a firm which has comparatively low debt content.
Importance of Cost of capital: * It is relevant in the field of managerial decision as this dynamic concept is affected by a company’s capital structure, its’ financing plans for the future and any changes in the rate of earnings. * When taking decisions based on Net Present Value method, the cost of