StudentShare solutions

# The Cost of Capital - Essay Example

## Extract of sampleThe Cost of Capital

Richard Brealey (2001) mentions cost of capital represents the interest paid for the borrowed funds. Cost of capital can also include focusing on Capital Asset Pricing Model (Sheridian, Martin & Keown, 2010). The formula determines the appropriate expected return of alternative projects. The cost of capital is the amount that the investor has to pay in order to generate a series of future dividend incomes, return of investments (Sheridian, Martin & Keown, 2010). For example, Geoff Black (2010) reiterated the business earns \$1,000,000 in one year. The profits will grow by 2 percent per year, and the company generates a net worth of \$16,666,667 after two years. The cost of capital is arrived at as follows: \$1,000,000 /(X- 2%) = \$16,666,667. X represents the cost of capital. After computing the formula, X is equal to 8 percent cost of capital figure. Further, the cost of capital can include the return that the stock market investors are expected to earn from their investments in a company. The firm that generates revenues more than the amount of cost of capital will entice the company’s current and prospective investors to invest additional funds into the invested company’s coffers. For example, Microsoft generated a 53 percent return on its equity. The company’s equity is \$7.2 billion. Computing, the company’s return on equity is \$3.8 Billion. ...
Brealey (2001) insists the managers can comment “I think I can understand a little of our shareholders’ worries,” the financial manager replies. “Just look at our return on assets. It’s only 6 percent, well below the cost of capital. Sure we are making a profit, but that profit does not cover the cost of the funds that investors provide. Our economic value added is actually negative. Of course, this doesn’t necessarily mean that the assets could be used better elsewhere, but we should certainly be looking carefully at whether any of our divisions should be sold off or the assets redeployed” Going further, the cost of capital can incorporate inventory storage costs. These amounts show that inventory capital investment contains both costs and benefits. The cost of the firm’s inventory investment in trade receivables is the interest figure that could have been earned when the clients paid their liabilities on an earlier date. The entity also forgets the issue of interest income when it includes idle cash amounts instead of investing the same amounts to generate profits in marketable securities. The cost of keeping product inventories embraces the opportunity cost of capital, storage costs, and insurance costs and the risk of spoilage or obsolescence. All of the carrying costs persuade the entities to keep the current assets to an allowable minimum level (Besley, 2008). When carrying costs prevent large investments in current assets, the very low level of current assets inventory makes it more probable that the entity will face shortage costs. For example, if the entity generates an empty inventory of raw materials, the entity can be ...Show more

## Summary

The cost of capital Customer Inserts His/Her Name Customer Inserts Grade Course Customer Inserts 14 March 2012 Businesses can generate cash inflows from loans. The research focuses on the reasons for paying the cost of capital. The research includes different cost of capital sources…
Author : kuvalisjules
Save Your Time for More Important Things
Let us write or edit the essay on your topic
"The Cost of Capital"
with a personal 20% discount.
Grab the best paper

### Related Essays

Petrobras and cost of capital
There is also importance in noting that the costs associated with obtaining the two also reflect the relative risks for obtaining them. Therefore, a company that acquires the two at high costs has higher risks compared to one that obtains them at lower costs.
12 pages (3000 words) Essay
Why might the cost of capital fall if financial markets are no longer segmented What evidence is there of this effect
(Name) (Tutor’s Name) (Assignment) (Date) Why might the cost of capital fall if financial markets are no longer segmented? Introduction Financial market segmentation and cost of capital are two interrelated concepts. Increased segmentation of financial market causes a subsequent increase in cost of capital.
4 pages (1000 words) Essay
The Capital Structure Decision and the Cost of Capital
In addition, the research focuses on determining the beta of the three companies. The best financial leverage is the medium debt ratio plan. Mattel Mattel (http://finance.yahoo.com/q/bs?s=MAT+Balance+Sheet&annual) is engaged in the manufacture and marketing of toy products.
4 pages (1000 words) Essay
Capital Structure Decision and the Cost of Capital
It can be impacted by the cost of issuing debt and equity, effect on the debt-equity ratios, shareholder and creditor mindsets and even a possibility of bankruptcy. In this case assignment we will look at the debt equity ratios and financial performance for three companies- eBay, the Clorox Company and Darden Restaurants while making a recommendation for the ideal capital structure for each company.
5 pages (1250 words) Essay
The Weighted Average Cost of Capital
As more and more debts are attained, the cost advantage of debt over equity makes the weighted average cost of capital decrease until the point when more of cheaper funds and less of expensive equity funds are used. After this point, both the cost of debt and cost of equity start to increase hence the weighted average cost increases.
3 pages (750 words) Essay
Critically evaluate the strategic financial concerns for a typical international investment projects. Explain why the cost of capital (of the fund or company) c
To start with, there ought to be an appropriate comprehension of the vision of the organization as well as the
6 pages (1500 words) Essay
Cost of capital
Hence, it is important that managers are aware of the consequences of every investment (Samuels, Wilkes, & Brayshaw, 2000). This report aims at analyzing the feasibility of acquiring a supplier by the
3 pages (750 words) Essay
The cost of capital
A layman’s term for cost of capital includes the amount paid for borrowing money from the bank, friends, and other lending institutions. Richard Brealey (2001) mentions cost of capital represents the interest paid for the borrowed funds. Cost of capital can also include focusing on Capital Asset Pricing Model (Sheridian, Martin & Keown, 2010).
3 pages (750 words) Essay
DiscussionAnalyzing Cost of Capital
The company needs to determine the best proportion of equity and debt that will keep the cost of capital at minimum, and which can be effectively managed by the firm. The overall cost of capital is measured by the weighted average cost of capital (W.A.C.C).
1 pages (250 words) Essay
Cost of Capital
panies requires to know how to balance their debts with the available equity, so that it becomes possible for the companies to ensure that they are capable of undertaking their normal operations, while at the same time still ensuring that they have the capacity to cover their
2 pages (500 words) Essay
Get a custom paper written
by a pro under your requirements!
Win a special DISCOUNT!
Put in your e-mail and click the button with your lucky finger