“By applying capital to investments with long-term benefits, the company is attempting to produce value. This value is dependent on expected future cash flows as well as on the cost of funds.” Explain this statement with regards to the role of cost of capital in financial management decisions.
Word Limit: 120 words maximum.
Cost of capital is the
cost of capital raised through equity, debt and preferred stock by
the company. Cost of capital is the weighted average cost of all
sources of capital. It also represents the risk involved in the
business. It is the discount rate used to discount future cash
flows to obtain the intrinsic value of a company. Companies try to
minimise the cost of capital by opting for optimum capital
structure and use of retained earnings to maximize the intrinsic
value of the firm.
Cost of
capital = Cost of equity * Weight of Equity + Cost of Debt *(1-tax
rate)* Weight of debt+Weight of Preferred Stock*Cost of Preferred
Stock.
“By applying capital to investments with long-term benefits, the company is attempting to produce value. This...
“By applying capital to investments with long-term benefits, the company is attempting to produce value. This value is dependent on expected future cash flows as well as on the cost of funds.” Explain this statement with regards to the role of cost of capital in financial management decisions.
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