Financial Management_Cost of Capital

1. COST OF CAPITAL
Presentation by
POULAMEE SAHA ROY
MBA 2ND SEM

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.

14. THANK YOU