Cost of Capital By Heena Malhotra
Meaning of Cost of Capital OCost of capital is the return expected by the providers of capital (i.e. shareholders, lenders and the debt-holders) to the business as a compensation for their contribution to the total capital. O This cost of capital expressed in rate is used to discount/ compound the cashflow or stream of cashflows. Cost of capital is also known as 'cut-off' rate, 'hurdle rate', minimum rate of return' etc. Olt is used as a benchmark for: Framing debt policy of a firm. By Heena Malhotra . Educating Capital budgeting decisions.
SIGNIFICANCE OF THE COST OF CAPITAL (i) Evaluation of investment options (ii) Performance Appraisal By Heena Malhotra
DETERMINATION OF THE COST OF CAPITAL The cost of capital can either be explicit or implicit. The cash outflow of an entity towards the utilization of capital which is clear and obvious is termed as explicit cost of capital. These outflows may be interest payment to debenture holders, repayment of principal amount to financial institution or payment of dividend to shareholders etc. On the other hand Implicit cost is the cost which is actually not a cash outflow but it is an opportunity loss of foregoing a better investment opportunity by choosing an alternative option. An entrepreneur for example, uses its bank deposits which earns interest @ of 9% p.a. for the business purpose. Using its bank deposits for business purpose means forgoing interest earnings from the bank on this deposit. The cost of capital in this case will be 9% interest that could have been earned by not investing the deposit for the business purpose. This opportunity loss of 9% is called implicit cost capital or opportunity cost By Heena Malhotra
Cost of Equity Weighted Cost of Retained Average Earnings Cost o Pref. Share Capital Cost of Capital (WACC) Cost of Long term Debt. By Heena Malhotra