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Cost of capital

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  • 1. Cost ofCapital
  • 2. Introduction The cost of capital is the cost of a companys funds (both debt and equity)or,from an investors point of view "the expected return on a portfolio of all the companys 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.
  • 3. 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
  • 4. What does cost of capital mean? The cost of capital is the rate of return that capital could be expected to earn in an alternative investment of equivalent risk. Costof capital includes the cost of debt and the cost of
  • 5. Importance of Cost of CapitalThe concept of cost of capital is crucial in financial management. Like any other source of finance has a cost and cannot, therefore, be used in the most effective manner unless that cost can be
  • 6. TYPES OF COST OF CAPITAL1)COST OF EQUITY (Ke)2)COST OF DEBT (Kd)3)COST OF PREFRENCE SHARES(Kp)4)COST OF RETAINED EARNINGS
  • 7. Cost of Equity The annual rate of return that an investor expects to earn when investing in shares of a company is known as the cost of equity. It is denoted by Ke. Formula- Ke = D X 100 P
  • 8. Cost of DebtCost of debt capital is associated with the amount of interest that is paid on currently outstanding debts. It is denoted by Kd.Formula-Cost of Debt = I (1 - TAX) I = Interest
  • 9. Cost of Preference shares The preference share capital is different from equity share capital on account of two basic features : 1)the preference shares are entitled to receive dividends at a fixed rate in priority over equity shares. 2)in case of liquidation of the company ,the preference shareholders will get the capital repayment in priority over the distribution among the equity share holders.
  • 10. Cost of Retained EarningsInaccounting, retainedearnings refers to theportion of net incomewhich is retained by thecorporation rather thandistributed to its ownersas dividends.
  • 11. Weighted Average Cost of CapitalA calculation of a firms cost of capital in which each category of capital is proportionately weighted.Formula- WACC = TOTAL WEIGHTED COST X 100 TOTAL CAPITAL
  • 12. Capital StructureCapital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firms capital structure is then the
  • 13. Debt financing Debtfinancing is basically money that you borrow to run your business.Types- Long term debt financing . Short term debt financing.
  • 14. Capital Budgeting Capitalbudgeting is the planning process used to determine whether a firms long term investments such as new machinery, replacement machinery, new plants, new products, and research development projects are
  • 15. Pay back period Thelength of time required to recover the cost of an investment. Formula-
  • 16. Return On New Invested CapitalA calculationused, either by a firmor investors, todetermine the amount ofreturn that a firmcould earn on additional
  • 17. RiskThe chance that aninvestments actualreturn willbe different thanexpected. This includesthe possibility of losing
  • 18. Weighted Average Cost of Equity• A wayto calculate thecost of a companysequity that givesdifferent weight todifferent aspects ofthe equities.
  • 19. Case study on nike
  • 20. PPT ByAaryendr