Question

Costs of Capital vs Opportunity Costs

1. What connection do you think exists between the costs of capital and "opportunity costs?"
2. Why do you think firms don't list the costs of capital on their financial statements?
3. Who receives payment of capital costs?

Answer 1

• Cost of Capital of a firm can be defined as the total average cost invested in a specific project. Cost of capital is a vital component to know the value or worth of a business. The opportunity cost of capital gives us a picture of other opportunities available for us to invest our capital in the present time or in the near future. The opportunity costs are more important to a firm or project as it provides a comparison among various capital investment options available. So, an investment's opportunity cost of capital is more vital and higher than the (Financial) cost of capital.
• So by analysing the opportunity cost of capital & rate of return an investor decide whether or not to invest in a certain project or not. if the rate of return is higher than the opportunity cost, investing in that project is advisable.
• The cost of both debt & equity of a firm together considered as the cost of capital. Cost of capital of a company is affected by various factors like the interest rates, dividend policy , income tax rates financial and investment decisions made by the business etc. Financial statement of a company represents or give an overall view of the financial position and financial performance of a company for a financial year. The financial statement consist of balance sheet, income statements & owner's equity statement which shows the changes in equity of the company in the balance sheet. Due to cost of capital varies by several factors and it is a cumulative of debt and equity it does not provide a specific or exact value of cost of investment or cost of financing a business/ project. It is the average value .So, it is not considered in the financial statement of firms.
• The company makes the payment of capital costs in order to raise funds,for capital investments (long term investments) etc.The payment may be made to bank as loan securing or to Government or  corporations for  bonds borrowing etc. it depends on the decision of the owner of the business how he/she wants to raise funds for his/her company. The capital cost is paid accordingly. If the owner invest the capital cost from previous profit or from his/her savings the payment is made by the company to the owner himself/herself.