2. “Cost of capital refers to the opportunity cost of
making a specific investment. It is the rate of return
that could have been earned by putting the same money
into a different investment with equal risk. Thus,
the cost of capital is the rate of return required to
persuade the investor to make a given investment.”
3. The cost of capital is the weighted-average, after-tax cost of a
corporation's long-term debt, preferred stock, and
the stockholders' equity associated with common stock. The
cost of capital is a percentage and it is often used to compute
the net present value of the cash flows in a proposed
investment. It is also considered to be the minimum after-tax
internal rate of return to be earned on new investments.
Funding Type
Funding
Amount
% Cost
Debt $50,800,000 5.8%
Preferred Stock $12,875,000 8.0%
Common Stock $72,375,000 15.5%
Totals $136,050,000 11.2%
4. The explicit cost of any sources of capital may be defined as the
discount rate that equates the present value of the cash inflows that
are incremental to the taking of the financing opportunity with the
present value of its incremental cash outflows. When a firm raises
funds from different sources, it involves a series of cash flows.
In economics, an implicit cost, also called an imputed cost,
implied cost, or notional cost, is the opportunity cost equal to
what a firm must give up in order to use a factor of production
for which it already owns and thus does not pay rent. It is the
opposite of an explicit cost, which is borne directly.
5. If a company changes its investment policy relative to its risk, both the cost of
debt and cost of equity change. The level of interest rates will affect the cost
of debt and, potentially, the cost of equity. For example, when interest rates
increase the cost of debt increases, which increases the1. Capital Structure
Policy
1.Capital survey policy
, a firm has control over its capital structure, targeting an optimal capital
structure. As more debt is issued, the cost of debt increases, and as more
equity is issued, the cost of equity increases.
2. Dividend Policy
Given that the firm has control over its payout ratio, the breakpoint of the
MCC schedule can be changed. For example, as the payout ratio of the
company increases the breakpoint between lower-cost internally generated
equity and newly issued equity is lowered.
3. Investment Policy
It is assumed that, when making investment decisions, the company is
making investments with similar degrees of risk. If a company changes its
investment policy relative to its risk, both the cost of debt and cost of equity
change.
