Introduction The cost of capital is very important factor in formulating firm’s capital structure. It is one of the cornerstones of the theory of financial management while deciding capital structure it is necessary to consider the cost of each source of capital and compare them to decide which source of capital is in the interest …
Cost of Capital
Proposals are taken up for execution a sensible approach is to analyze its viability from a different point of view. Every investment should be thoroughly analyzed such as its cost involved, cost of borrowed capital which should be compared with its revenues derived. The best criteria for the selection of a project to study the cost of investment be compared with an expected return on the investment.
When the cost of capital required for the new investment proposal is less than its expected return, such investment proposal be selected. The capital for a project can be borrowed from issuing equity and preference shares. Debentures, Bank loans and retained earnings etc.
In this chapter, the cost of capital of different sources is explained and calculated and in the end composite cost of capital or weighted cost of capital will be calculated it will be compared with its earnings.
On the basis of the excess of the return on investment than its cost of capital will be recommended for implementation. Whenever any new investment proposal is undertaken by any organization, the firm compares its viability from a different point of view. The firm carefully decides whether it should accept or reject depends upon the cost of capital required for investment. The cost is compared with the return of investment.
The capital for a project is arranged from different sources such: Equity shares, preference shares, debentures, Bank loans etc. So be on the safer side one must calculate the cost of each capital and after that, the composite cost of all capital is calculated. The object of this chapter is to highlight the cost of the different source of capital and its measurement are explained in detail.