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    FM1 Unit 5 Theory On Cost of Capital

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    Simran
    The document discusses cost of capital and capital structure. It defines cost of capital as the minimum return required to finance a company's operations using different sources of funds such as equity, debt, and retained earnings. It describes how weighted average cost of capital (WACC) is used to calculate the average cost of capital when a company uses multiple sources of financing. The document also discusses factors considered when designing a company's capital structure, such as balancing costs and risks associated with different sources of funds.

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    FM1 Unit 5 Theory On Cost of Capital

    Uploaded by

    Simran
    5 views3 pages
    The document discusses cost of capital and capital structure. It defines cost of capital as the minimum return required to finance a company's operations using different sources of funds such as equity, debt, and retained earnings. It describes how weighted average cost of capital (WACC) is used to calculate the average cost of capital when a company uses multiple sources of financing. The document also discusses factors considered when designing a company's capital structure, such as balancing costs and risks associated with different sources of funds.

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    FM1 Unit 5 Theory on Cost of Capital

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    The document discusses cost of capital and capital structure. It defines cost of capital as the minimum return required to finance a company's operations using different sources of funds such as equity, debt, and retained earnings. It describes how weighted average cost of capital (WACC) is used to calculate the average cost of capital when a company uses multiple sources of financing. The document also discusses factors considered when designing a company's capital structure, such as balancing costs and risks associated with different sources of funds.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    5 views3 pages

    FM1 Unit 5 Theory On Cost of Capital

    Uploaded by

    Simran
    The document discusses cost of capital and capital structure. It defines cost of capital as the minimum return required to finance a company's operations using different sources of funds such as equity, debt, and retained earnings. It describes how weighted average cost of capital (WACC) is used to calculate the average cost of capital when a company uses multiple sources of financing. The document also discusses factors considered when designing a company's capital structure, such as balancing costs and risks associated with different sources of funds.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 3

    UNIT V : COST OF CAPITAL

    Cost of Capital is the minimum required rate of earnings which a co. must earn
    in order to retain the funds which it has obtained from different sources such
    as ,Equity Capital,Preference Capital, Borrowed Funds/Debentures ,Retained
    Profits .
    Cost of Capital can be calculated using WACC [Weighted Avg Cost of Capital] or
    Marginal Cost of Capital.
    Weighted Avg Cost of Capital is for the various sources of finance of the
    company.
    Firms employ a mix of different types of capital such as Equity, Preference,
    Debt. Hence ,to determine the company’s Cost of Capital ,the average Cost of
    Capital is to be determined ,therefore we use WACC.
    Cost of Capital is very useful in designing the Capital Structure of a company.
    Capital Structure refers to the total value of Own Funds such as Equity
    ,Preference & Retained Profits and Borrowed Funds such as Debentures
    While designing the Capital Structure, ie Proportion of Owned Funds &
    Borrowed Funds ,the Finance Manager has to keep in mind the Cost of Capital
    & risks related to each source of Finance.

    A] Essentials of an Optimum Capital Structure


    Following are the main essentials of an optimum capital structure:
    i]Flexibility
    Capital structure should facilitate further financing requirements for
    expansion etc. It should be able to adapt itself to changing situations
    at a minimum cost ,without any delay.
    ii]Control :
    An ideal capital structure should involve minimum risk of loss of
    control of existing shareholders. Dilution/loss of control happens
    when company takes up excessive debt financing .Exessive use of
    debt financing may threaten company’s survival.
    iii]Returns
    Revenues/ Returns earned should be sufficient enough to pay
    creditors interests & principle on maturity. Also, it should generate
    maximum returns to the shareholders for a considerable period of
    time.
    iv] Risk
    Use of excessive Debt funds may threaten company’s survival. Main
    reason for this is whether company’s profits are sufficient or not,
    company has to pay the interest & principle. If the company is unable
    to do so, lenders may use various options [such as disposing
    collateral assets etc] to recover their dues. Hence, for avoiding risk,
    Debt Financing should be used when profits are sufficient to meet
    the fixed interest costs & repayment of principle.
    B] Factors Influencing Dividend Policy
    Key factors which influence the dividend payout of a firm are :
    i] Liquidity
    Dividend Payout involves Cash Outflow for the firm .Hence Dividend
    Payout decision depends on the Liquidity Position of the company
    ii]Investment Opportunities
    Another factor is the requirement of capital by the firm. If there are
    many profitable opportunities for growth ,company may retain more
    profits and pay less dividend and if there not enough growth
    opportunities for the co. it may pay more dividends and retain less
    profits.
    iii] Access to Finance
    Companies which have an easy access to finance pay more dividends.
    iv] Dividend Stability
    Company’s earnings may fluctuate during different time intervals
    .But most firms do not want to give fluctuating dividends .They try to
    maintain stability in dividends .
    v] Returns Earned
    Returns ,whether high or low ,influence dividend payouts .Higher the
    returns , higher can be dividend payouts.
    vi] Competition
    Dividend Policy of competitors have to be taken into consideration
    vii] Management Philosophy
    If Management understands shareholders desire to receive higher
    dividends or to have higher future growth ,they may take decisions
    as per their majority

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