2. DEFINITION
Cost of capital is the minimum rate of
return required on investment projects to
keep the market value per share
unchanged.
Capital of the firm may be in the form of
debt, equity shares, preference shares
and retained earnings.
3. SIGNIFICANCE
Helpful in capital budgeting process
Helpful in designing the firm’s capital
structure.
Helpful in evaluating the financial
performance
Basis for other financial decisions like
policy, working capital decisions etc.
4. TYPES
Cost of Debt (Kd)
Cost of Preference Shares (Kp)
Cost of Equity Shares (Ke)
Cost of Retained Earnings
5. COST OF DEBENTURES
It may be defined as the returns expected
by the returns expected by the potential
investors of debt securities of the firm.
It is represented by Ke or Cd.
It is calculated as before tax cost.
6. CALCULATION OF COST OF
REDEEMABLE DEBT CAPITAL
Kd =
I+{MV-NP}/n
×100
{MV+NP}/2
Where, i = Interest
MV= Maturity Value
NP= Net Proceeds
n= Number of years to maturity
7. CALCULATION OF COST OF
IRREDEEMABLE DEBT CAPITAL
Kd = [ i / NP ] x100
Where, i = Interest
NP= Net Proceeds
8. COST OF PREFERENCE SHARE
CAPITAL
Cost of preference share capital is in terms
of the fixed rate of dividend.
This is the hybrid form of financing that
has certain characteristics of equity and
certain attributes of debentures.
9. CALCULATION OF COST OF
PREFERENCE SHARE CAPITAL
Kp =
DPS
×100
NP
Where, Kp = Cost of Preference Share
DPS = Dividend per share
NP = Net Proceeds
10. COST OF EQUITY
It is the annual rate of return that an
investor expects to earn when investing
in shares of a company.
It is denoted by Ke.
There is no commitment to pay equity
dividend.
11. CALCULATION OF COST OF
EQUITY SHARE CAPITAL
Ke =
DPS
×100
MP
Where, Ke = Cost of Equity Share
DPS = Dividend per share
MPS = Market Price Per Share
12. COST OF RETAINED EARNINGS
It is the opportunity cost of foregone
dividends.
It is represented by Kr.
The earnings to be retained are already
after tax.
Cost of retained earnings (Kr)= Cost of
Equity Share Capital (Ke)
13. WEIGHTED AVERAGE COST OF
CAPITAL – WACC
The weighted average cost of capital (WACC)
is a calculation of a firm's Cost of Capital in
which each category of capital is
proportionately weighted.
All sources of capital, including common stock,
preferred stock, bonds, and any other long-
term debt, are included in a WACC calculation.