Assignment on Cost of Capital

Cost of capital
Abstract
Cost of capital which is utilized as a financial standard assumes a critical part in
capital budgeting decisions. It is the discount rate applied for assessing the allure of
investment projects. An investment task can be acknowledged whether it has a positive net
present value. Additionally, financial decisions taken by the management of a firm are
fittingly assessed utilizing the weighted average cost of capital. The cost of capital impacts
debt policy of a firm. While planning the extent of debt and equity in the capital structure, a
firm targets limiting the overall cost of capital. The cost of capital is broadly utilized in
choosing about the way of financing at a specific place of time. It plays a significant part in
dividend decisions. Cost of capital is one of the significant measurements which chooses the
measure of investment in current assets. Keeping the significance of cost of capital in
corporate finance, this chapter will basically cover the cost of equity, cost of preferred
stock ,cost of debt and weighted average cost of capital.

01.Sources of capital
Liability
Equity
02.What is the cost of capital
The return the firm’s investor could expert to earn if they invested in securities with
comparable degrees of risk.
The firm’s cost of capital will be the overall or average required rate of return on the
aggregate of investment project.
The cost that company has to pay as dividends, interests , etc. in obtaining capital
from the sources like ordinary shares, preference shares or debentures.
03.Sources of long term capital
Sources Equity Preferred stock Long term debts
Cost Dividend Dividend Interest
03.1.Cost of Equity (Re) (Common stock)
Return that equity investors require on their investment in the firm.[ CITATION Ros3
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Investors require compensation for the risky they take.
Can calculated using,
a) Gordon growth model
b) Security market line approach
03.1.1.Advantages and disadvantages of Gordon growth model
Capital Structure
Firm’s cost of capital = cost of debt capital + cost of equity capital
Re = (D1 / P0) + g D1 – Next dividend P0 – Current price
g – Growth rate
Rf = risk free rate β = beta coefficient
(Rm - Rf) = market risk premium
Re = Rf + β (Rm - Rf)