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In: Business and Management

Submitted By saloni926
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Financial Management Decisions
COST-VOLUME-PROFIT ANALYSIS

2.2 Cost Of Capital
This Section includes :


Cost of Capital-Key Concepts



Importance



Classification



Determination of Cost of Capital



Computation



Weighted Average Cost of Capital

INTRODUCTION:
It has been discussed in lesson -4 that for evaluating capital investment proposals according to the sophisticated techniques like Net Present Value and Internal Rate of Return, the criterion used to accept or reject a proposal is the cost of capital. The cost of capital plays a significant role in capital budgeting decisions. In the present lesson the concept of cost of capital and the methods for its computation are explained.
COST OF CAPITAL-KEY CONCEPTS:
The term cost of capital refers to the minimum rate of return a firm must earn on its investments. This is in consonance with the firm’s overall object of wealth maximization. Cost of capital is a complex, controversial but significant concept in financial management.
The following definitions give clarity management.
Hamption J.: The cost of capital may be defined as “the rate of return the firm requires from investment in order to increase the value of the firm in the market place”.
James C. Van Horne: The cost of capital is “a cut-off rate for the allocation of capital to investments of projects. It is the rate of return on a project that will leave unchanged the market price of the stock”.
Soloman Ezra:”Cost of Capital is the minimum required rate of earinings or the cut-off rate of capital expenditure”.
It is clear from the above difinitions that the cast of capital is that minimum rate of return which a firm is expected to earn on its investments so that the market value of its share is maintained. We can also conclude from the above definitions that there are three basic aspects of the…...

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