Significance of cost of finance, Finance Basics

Significance of Cost of Finance

The cost of capital is Significance since of its application in the following areas as:

i) Long-term investment decisions - In capital budgeting decisions, with NPV method, the cost of capital is required to discount the cash flows. Under IRR method the cost of capital is compared along with IRR to determine where to reject or accept a project.

ii) Capital structure decisions - The composition/mix of different components of capital is determined with the cost of each capital component.

iii) Evaluation of performance of management - A high cost of capital is a shows of high risk attached to the firm. It is generally attributed to poor performance of the firm.

iv) Dividend decisions and policy - as if the cost of retained earnings is low compared with the cost of new ordinary share capital, the firm will retain extra and pay fewer dividends.  Additionally, the utilization of retained earnings like an internal source of finance is preferred since:

  1. It does not contain any floatation costs
  2. It does not dilute control and ownership of the firm, while no new shares are issued.

v) Lease or buy decisions - A firm may finance the acquisition of an asset with borrowing and leasing long-term debt to buy an asset. So in lease or buy decisions, the cost of debt interest rate on loan borrowed is used like the discounting rate.

Posted Date: 1/30/2013 2:51:58 AM | Location : United States







Related Discussions:- Significance of cost of finance, Assignment Help, Ask Question on Significance of cost of finance, Get Answer, Expert's Help, Significance of cost of finance Discussions

Write discussion on Significance of cost of finance
Your posts are moderated
Related Questions
Monitoring Costs - Agency Costs This is incurred to prevent undesirable managerial actions. They are meant to ensure that both parties live to the spirit of agency contract. T

Tarniwala and Dealer in Non-cleared Securities Tarniwala: He/she is a specialist or jobber in selected shares. He/she makes market i.e. provide continuity to dealings. They

Partnership Definition -Partnership may be defined as a relationship between persons carrying on a business in common with a view of profits. In partnership business, two or mo

Klose Outfitters Inc. believes that its optimal capital structure having of 60% common equity and 40% debt, and its tax rate is 40%. Klose have raise additional capital to fund its

Price - Sales of Goods Like where section 10 provides such the price for goods may like fixed by like: (i) Contract; and one is (ii) The manner provided within the contr

Problem: Cash Flow Analysis For the attached Gantt chart, the following information is available: Invoices are sent at the end of each month. Mark up is 20% on each invoi

What are the Types of orders (i) Spot Delivery: Spot delivery means delivery and payment on the same day as date of the contract or on the next day. (ii) Hand Delivery:

Mr. de Ville, the owner of Tasman Ian de Ville Holdings Ltd. (TIDH) has asked you to evaluate five investment projects. TIDH has a $10,000,000 investment budget, an investment hurd

Cost of Retaining Finance This will contains dividends for share capital and interest for debt finance or can say tax deducted or like effective cost of debt.  Though, when co

Question: A non-zero coupon bond carries a coupon rate of 8 percent and has 9 years until maturity. It sells at a yield to maturity of 6 percent. The par value of the bond is