THE BUSINESS SCHOOL (TBS)

UNIVERSITY OF JAMMU

PRESENTATION
ON
FINANCIAL MANAGEMENT

SUBMITTED TO:- SUBMITTED BY:-

Dr. AMISHA GUPTA AKSHIMA BALGOTRA

ROLL NO- 06
 COST
OF
CAPITAL
 Introduction
Thecost ofcapitalis the cost of a
company's funds and 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.
 Definition
The cost of capital is the minimum required
rate of earnings or the cut-off rate of
expenditure

-Solomon Ezra
The cost of capital represents a cut-off rate for
the allocation of capital to investments of
projects. It is the rate of return on a project that
will leave unchanged the market price of the
stock.

-James C. Van Horne

 MEANING
Cost of Capital is the minimum rate of return that
the firm must earn on the investment so that the
market value of the companys equity share does not
fall.

From the view point of return, cost of capital is the

minimum required rate of return to be earned on
investment.

The cost of capital is also referred to as the

discounting rate to determine the present value of
return.

Cost of capital includes the cost of debt and the cost

of equity.
For example, if a person has Rs 10,000 to invest
and must choose between Stock A and Stock B, the
cost of capital is the difference in their returns. If
that person invests $10,000 in Stock A and
receives a 5% return, while Stock B makes a 7%
return, the cost of capital is 2%.
One way of conceptualizing the cost of capital is
as the amount of money one could have made by
making a different investment decision.
Many companies calculate the cost of capital
when deciding whether to issue stock or a bond, to
determine which would be cheaper.
 Cost of Capital is also referred
as:
Minimum Rate of Return

Minimum attractive Rate of

Return
Required Rate of Return

Cost of funds

Cut-off Rate

Target Rate

Standard Rate

Discount Rate
 The projects cost of capital is the
minimum required rate of return on funds
committed to the project, which depends
on the riskiness of its cash flows.
The firms cost of capital will be the
overall, or average, required rate of return
on the aggregate of investment projects.
 Cost of Capital for Projects

For example, projects may be classified as:

Low risk projects

discount rate < the firms WACC

Medium risk projects

discount rate = the firms WACC

High risk projects

discount rate > the firms WACC

 CONCEPT
The firm invests the funds in various assets. So it should
earn returns that are higher than the cost of raising the
funds. In this sense the minimum return a firm earns must be
equal to the cost of raising the fund.

So the cost of capital may be viewed from two viewpoints

acquisition of funds and application of funds.

From the viewpoint of acquisition of funds, it is the

borrowing rate that a firm will try to minimize.

On the other hand from the viewpoint of application of

funds, it is the required rate of return that a firm tries to
achieve.
The cost of capital is the average rate of return required
by the investors who provide long-term funds.

In other words, cost of capital refers to the minimum

rate of return a firm must earn on its investment so that
the market value of companys equity shareholders does
not fall.

Cost of capital may be defined according to the

operational as well as the economic sense.

In the operational sense, cost of capital is the discount

rate. The cost of capital, as an operational criterion, is
related to the firms objective of wealth maximization.

In the economic sense, it is the weighted average cost

of capital, i.e. the cost of borrowing funds.
 TYPES OF COST OF CAPITAL

COST OF EQUITY (Ke)

COST OF DEBT (Kd)

COST OF PREFRENCE
SHARES (Kp)

COST OF RETAINED
 SIGNIFICANCE
Cost of capital is an important area in financial
management and is referred to as the minimum rate,
breakeven rate or target rate used for making different
investment and financial decisions. The significance and
relevance of cost of capital has been discussed below:

Evaluating Investment Decisions

Designing Firms Debt Policy

Appraising the Financial Performance of Top

Management
 IMPORTANCE
The cost of capital is very important concept in the financial
decision making.

Cost of capital is the measurement of the sacrifice made by

investors in order to invest with a view to get a fair return in
future on his investments as a reward for the postponement
of his present needs.

On the other hand from the point of view of the firm using
the capital, cost of capital is the price paid to the investor for
the use of capital provided by him. Thus, cost of capital is
reward for the use of capital.

The progressive management always likes to consider the

importance cost of capital while taking financial decisions as
Capital Budgeting Decisions

Designing the Optimal Capital Structure

Deciding about the Method of Financing

Performance of Top Management

Knowledge of firms expected income and inherent

BIBLIOGRAPHY
TH A NK
YO U