2. Introduction
The cost of capital is the cost of a
company's funds
(both debt and equity)or,from an
investor's point of view "the expected
return on a portfolio of all the
company's existing securities".
It is used to evaluate new projects of
a company as it is the minimum
return that investors expect for
providing capital to the
company, thus setting a benchmark
that a new project has to meet.
3. Definition
“The cost of capital is the minimum
required rate of earnings or the cut-off
rate of expenditure” -Solomon
Ezra
“The cost of capital represents a cut-off
rate for the allocation of capital to
investments of projects. It is the rate of
return on a project that will leave
unchanged the market price of the stock.”
-James C. Van Horne
4. What does cost of capital
mean?
The cost of capital is the rate
of return that capital could be
expected to earn in an
alternative investment of
equivalent risk.
Costof capital includes the
cost of debt and the cost of
5. Importance of Cost of
Capital
The concept of cost of
capital is crucial in financial
management. Like any
other source of finance has
a cost and cannot,
therefore, be used in the
most effective manner
unless that cost can be
6. TYPES OF COST OF
CAPITAL
1)COST OF EQUITY (Ke)
2)COST OF DEBT (Kd)
3)COST OF PREFRENCE SHARES
(Kp)
4)COST OF RETAINED EARNINGS
7. Cost of Equity
The annual rate of return that
an investor expects to earn
when investing in shares of a
company is known as the cost
of equity. It is denoted by Ke.
Formula-
Ke = D X 100
P
8. Cost of Debt
Cost of debt capital is
associated with the amount
of interest that is paid on
currently outstanding debts.
It is denoted by Kd.
Formula-
Cost of Debt = I (1 - TAX)
I = Interest
9. Cost of Preference shares
The preference share capital is different
from equity share capital on account of
two basic features :
1)the preference shares are entitled to
receive dividends at a fixed rate in
priority over equity shares.
2)in case of liquidation of the company
,the preference shareholders will get the
capital repayment in priority over the
distribution among the equity share
holders.
10. Cost of Retained Earnings
Inaccounting, retained
earnings refers to the
portion of net income
which is retained by the
corporation rather than
distributed to its owners
as dividends.
11. Weighted Average
Cost of Capital
A calculation of a firm's cost
of capital in which each
category of capital is
proportionately weighted.
Formula-
WACC = TOTAL WEIGHTED COST X
100 TOTAL CAPITAL
12. Capital Structure
Capital structure refers to
the way a corporation
finances its assets through
some combination of
equity, debt, or hybrid
securities. A firm's capital
structure is then the
13. Debt financing
Debtfinancing is basically
money that you borrow to run
your business.
Types-
Long term debt financing .
Short term debt financing.
14. Capital Budgeting
Capitalbudgeting is the
planning process used to
determine whether a firm's
long term investments such as
new machinery, replacement
machinery, new plants, new
products, and research
development projects are
15. Pay back period
Thelength of time required to
recover the cost of an
investment.
Formula-
16. Return On New
Invested Capital
A calculation
used, either by a firm
or investors, to
determine the amount of
return that a firm
could earn on additional
17. Risk
The chance that an
investment's actual
return will
be different than
expected. This includes
the possibility of losing
18. Weighted Average
Cost of Equity
• A wayto calculate the
cost of a company's
equity that gives
different weight to
different aspects of
the equities.
