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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.

86 LOVELY PROFESSIONAL UNIVERSITY