Question

Discuss the importance of cost of capital. Discuss the various options to inject capital into a company. What are the pros and cons of each? What is the difference between equity and debt funding?

Answer 1

COST OF CAPITAL is the amount of return from an investment.it can be from equity,debt etc.It is the opportunity cost involved when investing the funds to one project over other.

importance

1-capital budgeting decision-the main purpose or use of CC is to take the best project proposal from various investment proposal

2-evaluating financial performance-CC helps to check the financial status of investment.can get detailed feasibility of the proposal

3-financing and dividend decisions-CC can be helpful for taking decisions regarding dividend policy,capitalization of profit,working capital arrangement etc.

4-comparative study of source of financing-According to CC they can decide which proposal is giving high return.a comparative study is possible

various options to inject capital into a company.

debt financing-debt include debentures,bonds,term loan etc,debt may be perpetual debt,or redeemable debt and can be issued at par,premium,or at discount.

PROS-

it is the cheap source of finance

less risky

tax advantage

CONS-

Low return on investment

increase the interest liability

equity financing-it can be equity shares and preference shares.by issuing shares ,the company can raise funds

PROS-

high return

no fixed payment of interest

investors network will increase the credibility

CONS-

no tax advantage

not a cheap source of finance

involves huge risk

difference between equity and debt funding

DEBT	EQUITY
Funds owed by the company towards another party is known as Debt.	Funds raised by the company by issuing shares is known as Equity.
Loan Funds	Own Funds
Is an Obligation	Gives Ownership
Comparatively short term	Long term
Holders are Lenders	Holders are Proprietors
Less risk	High risk
Includes Term loan, Debentures, Bonds etc.	Includes Shares and Stocks.
Return is Interest	Return is Dividend
Fixed and regular	Variable and irregular