Question

1. Which factors influence the cost of capital of a publicly traded firm?

Answer 1

There are three kinds of factors which influence the cost of capital of a business. These are-

1. Fundamental factors

2. Economics and other factors

3. Individual company factors

1. Fundamental factors

Fundamental factors are market opportunities, Capital provider preferences, risk and inflation which influence the cost of capital.

Market opportunities means law of demand and supply. When demand of capital increases, the cost of capital also increase and so on.

Capital provider preference means whether the investor wants to consume his saving or want to invest it. They will invest more if they get higher returns.

Risk. If the project/venture is risky, it has to pay higher returns for the investment. Thus cost of capital will be high.

Inflation. When an investor invest in any fund, he would like to earn real income (actual income - inflation).

2. Economic and Other factors

Economics and other factors are Federal reserve policy, Federal budget deficit and surplus, Trade activity, Foreign trade surplus or deficit, Country Risk, Exchange rate risk.

3. Individual Company factors

Individual company factors are capital structure policy, Dividend policy, Investment Policy. Capital structure policy means whats the capital structure of the business, how much is debt and how much is equity. Dividend policy means how much profit it is distributing to its shareholders and how much it retaining. Investment policy means where the company is investing its fund, if its a risky project, it has to pay higher returns.