Cost of Capital
Cost of Capital
Cost of Capital
Cost Of Capital
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.
K=C + b +f
Where,
K=cost of capital;
C=the riskless cost of financing;
b=business risk premium; f=financial risk
premium.
Financial Management
CAPITAL STRUCTURE
THEORIES
In finance, capital structure refers to the
way a corporation finances its assets through
some combination of equity, debt, or hybrid
securities.
First stage
In the first stage the overall cost of capital
falls and the value of the firm increases with the
increase in leverage. This leverage has beneficial
effect as debts as debts are less expensive. The
cost of equity remains constant or increases
negligibly. The proportion of risk is less in such a
firm.
Second stage
A stage is reached when increase in leverage has
no effect on the value or the cost of capital, of
the firm. Neither the cost of capital falls nor the
value of the firm rises. This is because the
increase in the cost of equity due to the assed
financial risk offsets the advantage of low cost
Financial Management