COST OF CAPITAL

MEANING

Minimum required rate of return, a project

must earn to cover up the cost

It should be sufficient to pay off the

investors of the firm

It is Break Even amount any company need

to run the business
 IMPORTANCE

Helps to maximise shareholder’s wealth

Supports to make financial decisions
Basis for evaluating financial performance
Helps to select the projects
Suggest ways to reduce costs
Decision taken can be used for several ways like:
A) Distribution of dividend
B) Reinvestment in firm for growth
 SOURCES OF CAPITAL

Owned Borrowed
funds funds

Equity
Bank Loan
Shares

Preference
Debentures
shares

Retained
Bonds
Earnings
EQUITY SHARE CAPITAL

Risk Capital

Fluctuating dividend

Voting rights
Prospect for capital
appreciation
Controlling Power

Right issue of share

 PREFERENCE SHARES

First
Preference Repayment Redeemabi Fixed
Less risky
for of capital lity dividend
dividend
 DEBT/ LOANS

Borrowed Fixed Priority in

capital Interest repayment

No voting No right
rights issue of
 COST OF DEBT

1) Irredeemable Debt – Debt with no maturity period

Formula- Kd = __I__ * (1-t) *100
NP
2) Redeemable Debt – Debt which company will buy back on or before
maturity
Formula – Kd = I(1-t) + ((RV-NP)/n)
RV+NP/2
Kd= Cost of Debt
I = Annual Interest
t= Tax
N= maturity
NP= Net Proceeds ( Issue price - Expenses of issue)
RV= Par Value of debentures
 ISSUE PRICE VARIATION

1) At Par – Company is issuing debentures at face value only

2) At Premium – Issue is with some additional percentage on
face value
3) At Discount – Issue is with some deducted amount on face
value

For Eg. If issue is done at face value of Rs. 1000

1) At par means issuing with same price of face value i.e. Rs.
1,000
2) At premium of 10%- 10% additional on face value= Rs.
1,100
3) At Discount of 10% - 10% deduction from face value = Rs.
 COST OF PREFERENCE SHARES

1) Irredeemable PS – PS with no maturity period

Formula- Kp = __D__ * 100
NP
2) Redeemable PS – Debt which company will buy back on or before
maturity
Formula – Kp = D + ((RV+NP)/n) *100
RV+NP/2
Kd= Cost of Preference Shares
D = Annual Dividend
t= Tax
N= maturity
NP= Net Proceeds ( Issue price- Expenses of issue)
RV= Par Value of debentures
 COST OF RETAINED EARNINGS

1) Retained earnings= Amount of profit

retained by the company for growth purpose
( Not given to share holders as dividend)
2) Ke= Retained earnings Cost
3) Retained Earnings cost = Ke ( 1-t) (1-b)
T= Tax
B= Brokerage cost
 WACC

1) WACC= Weighted Average Cost of

Capital
2) Average cost of the company in total
3) It will include cost of debt, preference
shares, equity , retained earnings etc.