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
Classification of Debenture Finance i) Secured Debentures These are those types of debentures which a company will secure generally in two ways, secured along with a fixe

Every time a listed company does a share buyback, investors and media alike would debate fiercely on the merits of such a scheme. There are investors who prefer buybacks to high

Capital Asset Pricing Model (CAPM) CAPM is a methods that is used to establish the required rate of return of an investment provided a particular level of risk.  According to

Louis Futon Co. is currently an all-equity firm. The current market value of the company is $80 million. The corporate tax rate is 35%. What is the new value of the company if Loui

Sources of Funds - Finance Venture capital, with combining risk financing along with marketing assistance and management, could become an effective instrument in fostering dev

finance is divided into _____ and___________

Finance Functions The functions of Financial Manager can broadly be split into two:  The Managerial Functions and The Routine functions. Managerial Finance Functions

Describe the duties of the financial manager in a business firm? Financial managers calculate the firm's performance, define what the financial consequences will be if the firm

Berick Ltd is a relatively small engineering company that manages to compete effectively with larger companies by adapting to changing market requirements and specialising in innov

Control of Pattern Formation Limbs such as all other organs have a pattern. What factor (or factors), environmental affects etc. are responsible for specific positioning of i