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Financial Management                                            Mahesh Kumar Sarva, Lovely Professional University



                      Notes                                 Unit 6: Cost of Capital



                                       CONTENTS
                                       Objectives

                                       Introduction
                                       6.1  Cost of Capital – Concept
                                       6.2  Importance/Significance of Cost of Capital
                                       6.3  Classification of Cost

                                       6.4   Computation of Specific Cost of Capital
                                           6.4.1   Cost of Equity
                                           6.4.2    Cost of Preference Shares

                                           6.4.3   Cost of Debentures/Debt/Public Deposits
                                       6.5  Weighted Average Cost of Capital (Wacc)
                                           6.5.1   Steps Involved in Computation of WACC

                                           6.5.2   Marginal Cost of Capital
                                           6.5.3   Factors Affecting Wacc
                                       6.6  Summary

                                       6.7  Keywords
                                       6.8  Review Questions
                                       6.9  Further Readings



                                    Objectives

                                    After studying this unit, you will be able to:
                                        Recognize the significance of cost of capital
                                        Discuss the basic aspects of the concept of cost of capital
                                        Categorize the costs
                                        Identify the factors that affect cost of capital

                                    Introduction

                                    The cost of capital is  an important concept in  formulating a  firm’s capital structure. Cost  of
                                    capital is a central concept in financial management. It is also viewed as one of the corner stones
                                    in the theory of financial management. It has received considerable attention from both theorists
                                    and practitioners. Two major schools of thought, have emerged having basic difference on the
                                    relevance of cost of capital. In one camp, Modigliani Miller argued, that a firm’s cost of capital is
                                    constant and it is independent of the method and level of financing. In another camp (traditionalists)
                                    cost of capital is varying and dependent on capital structure. In both the camps, optimal policy
                                    is taken as the policy that maximizes the value of a company.





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