Page 83 - DMGT409Basic Financial Management

Basic Financial Management

Notes 14. According to traditional approach, cost of capital is affected by debt equity MPC.

15. Cost of capital is useful in capital budgeting, in evaluation based on discounted cash fl ow
techniques only.
16. CAPM approach is one of the approaches used in computation of cost of equity capital.
17. In Bond yield plus risk premium approach of cost of equity, risk premium ranges between
2% to 6%.

4.8 Review Questions

1. What is the relevance of cost of capital in capital budgeting decisions?
2. Write a note on CAPM approach for calculation of cost of equity.

3. State any four methods of computing cost of equity.
4. The basic formula to calculate the cost of equity is D/P + g. Explain its rationale.
5. How is cost of debt calculated?
6. How is cost of preference share calculated?
7. Discuss the following bases for determining the weights in cost of capital calculation, book
values, target capital structure and market values.

8. How should you handle the flotation costs in the determination of cost of capital?
9. What are the steps involved in calculating a fi rm’s WACC?
10. What is cost of equity? Write a detailed note on the approaches available for computation
of cost of equity.

11. Define cost of capital. Discuss in detail the steps involved in computation of WACC.
12. “Evaluating capital budgeting proposals without cost of capital is not possible”. Discuss.
13. Critically evaluate the different approaches to the calculation of cost of equity capital.

Answers: Self Assessment

1. Minimum 2. Investor
3. Soloman Izra 4. ‘b’ business risk premium
5. discount rate 6. Overall cost of capital
7. Traditional approach 8. Marginal cost

9. Risk premium 10. Specifi c cost
11. True 12. True
13. False 14. True
15. True 16. True
17. True

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