1. Cost of Capital

2. Introduction
 The cost of capital is the minimum return rate required by the
business to be earned in order to meet the expectations of its
investors. Businesses to progress well and move with the
industry need to undertake new investments, new opportunities
and new projects. However, these new opportunities and
investments need some funds as well; you can’t simply start
any project without injecting funds in it. In such a situation,
the businesses make the use of the funds to be taken from a
group of people like, equity investors, preference shareholders
and debenture holders. This group of investors never offers the
funds without any return and the return being demanded by the
investors is the cost of capital for the investment.

3.  The opportunity cost of an investment; that is, the rate of
return that a company would otherwise be able to earn at
the same risk level as the investment that has been
selected. For example, when
an investor purchases stock in a company,
he/she expects to see a return on that investment. Since
the individual expects to get back more than
his/her initial investment, the cost of capital is equal to
this return that the investor receives, or the money that
the company misses out on by selling its stock.

4.  The term “cost of capital” is the combination of three
different investors and their returns over the
investments also called the components of the Cost
of Capital

5. DEFINITIONS
 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.

6. DEFINITIONS
 “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

7. 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 accurately
determined and taken into account.

8. Cost of Issuing Securities
 The cost of issuing new securities ,called flotation
cost
 Flotation costs consist of the underwriting spread
and other direct issue expenses include all other
flotation cost incurred by the issuer including legal
and accounting expenses ,printing cost ,registration
fees and taxes
 …. Underwriting spared is the rupee deference between the price that the
issuing firm receives from the underwriters and at the price at which the
underwriter sell the securities to the public, it is generally quite large.

9. Factors affecting Flotation Cost
 Types of Securitas…FC are typically higher for
common stock than for debenture
 Riskiness of an Issue…Low quality issue have higher
flotation cost than high quality issue because
underwriter bear more risk and incur higher cost in
selling low quality issue
 Size of the Issue…Small issues are more expensive as
a percentage of total fund raised than large issue
because many issuing cost are fixed.

10. 1)COST OF EQUITY (KE)
2)COST OF DEBT (KD)
3)COST OF PREFRENCE SHARES
(KP)
4)COST OF RETAINED EARNINGS
TYPES OF COST OF
CAPITAL

11. Cost of Equity
 The cost of equity amounts to the return being
expected by the equity holders for the shares being
funded to the investments. The cost of equity if
provided to the equity shareholders is in the form of
dividends however, there is no legally binding
obligation to the dividend payments.

12. 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

13. DEBENTURE
A debenture is defined as a certificate of agreement of loans
which is given under the company's stamp and carries an
undertaking that the debenture holder will get a fixed
return (fixed on the basis of interest rates) and the principal
amount whenever the debenture matures.

14. PREFERENCE SHARES
 Preference shares are those, which enjoy the following two
preferential rights:
1. Dividend at a fixed rate or a fixed amount on these shares
before any dividend on equity shares.
2. Return of preference share capital before the return
of equity share capital at the time of winding up of the
company.
Preference shares also have a right to participate or in part in
excess profits left after been paid to equity shares, or has a
right to participate in the premium at the time of redemption.
But these shares do not carry voting rights.

15. Equity Share
Shares that carry no preferential or special rights in respect of annual dividends
and in the repayment of capital at the time of liquidation of the company are
called equity shares. These shares carry no preferential rights; therefore, these
are also known as common stock or ordinary shares.
Dividend on such shares is payable only when there are profits after the
payment of preference dividend. But, the rate of dividend on these shares is
not fixed. Board of directors, depending upon the dividend policy as well as
the availability of profits after dividend on preference shares, declare dividend.
No dividend will be paid on these shares, if there are no profits or insufficient
profits in a particular year. The value of these shares in
stock exchange fluctuates on the basis of rate of dividend declared. Similarly,
these shares are redeemed only after the redemption of preference shares at
the time of liquidation of the company.
Equity share holders enjoy full voting rights in all matters of the company.
They have right to elect directors and participate in the management and
control of the company. They also share residual profits.


16. Cost of Debt
 The cost of debt is a part of the company’s cost of
capital and forms to be an important component.
The cost of debt is defined as the rate of interest
required to be paid by the company over the current
debt it has taken out to fund the investment. The
cost of capital considers the after tax cost of debt for
the calculation purpose. The funds can be borrowed
from financial institutions by taking a loan or by
issuing debentures or bond

17. 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

18. Cost of Preference Share Capital
 The cost of debt and cost of preference share capital
are more or less the same concept. However, there
are a few confusions in the concept of preference
share capital in a sense that the debenture holders
have a legal right to interest payments, whereas, the
preference shareholders have no legal right.
However, when compared to the equity shareholders
the preference shareholders are considered as a
priority.

19. 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.
It is denoted by Kp.

20. Cost of Retained Earnings
In accounting, retained earnings
refers to the portion of net income
which is retained by the
corporation rather than distributed
to its owners as dividends.

21. Weighted Average Cost of Equity
A way to calculate the cost
of a company's equity that
gives different weight to
different aspects of the
equities.

22. Weighted Average Cost of Capital
A calculation of a firm's cost
of capital in which each
category of capital is
proportionately weighted.
Formula-
 WACC = TOTAL WEIGHTED COST X
100 TOTAL CAPITAL

24. Capital Structure
Capital structure refers to the way
a corporation finances its assets
through some combination of
equity, debt, or hybrid securities.
A firm's capital structure is then
the composition or 'structure' of
its liabilities.

25. Debt financing
Debt financing is basically
money that you borrow to run
your business.
Types-
Long term debt financing .
Short term debt financing.

26. Capital Budgeting
Capital budgeting is the planning
process used to determine whether a
firm's long term investments such as
new machinery, replacement
machinery, new plants, new products,
and research development projects
are worth pursuing.

27. Pay back period
The length of time required to
recover the cost of an investment.
Formula-

28. Return On New Invested
Capital
A calculation used, either by a
firm or investors, to determine
the amount of return that a firm
could earn on additional
contributed capital.

29. Risk
The chance that an investment's
actual return will
be different than expected. This
includes the possibility of losing
some or all of the original
investment.