Home » **CONCEPT AND MEASUREMENT OF COST OF CAPITAL**

Dividend Approach
One approach to calculate the cost of equity capital is based on the dividend valuation model. According to this approach, the cost of equity capital is calculated on the basis of a required rate of return in terms of the future dividends to be paid on the shares. The cost of equity capital, k, is, accordingly, defined as the discount rate that equates the present value of all expected future

Cost of Equity Capital
The cost of equity capital is by far, conceptually speaking, the most difficult and controversial cost to measure, It has been shown in the preceding discussions that the coupon rate of interest which form s the basis of calculation of cost of debt can be estimated with a high degree of accuracy since intersect payments as well as the return of the principal are contractual obligations.

Perpetual Security
The cost of preference shares which has no specific maturity dare is given by Eq. (12.8) and Eq. (12.8A)
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Cost of Preference Shares
The computation of the cost of preference shares is conceptually difficulties compared to the cost of debt. In the case of debt, as shown above, the interest rate is the basis of calculating cost, as payment of a specific amount of interest is legal commitment on the part of the firm. There is no such obligation in regard to preference dividend. It is true that a fixed stipulated on pr

Cost of Perpetual Debt
The measurement of the cost of perpetual debt is conceptually relative easy. It is the rate of return which the lenders expect. The debt carries a certain rate of inter The coupon interest rate or the market yield on debt can be said to represent an approximation the cost of debt. The nominal/coupon rate of interest on debt is the before tax cost of debt. Since the effective cost of debt

Cost of Debt
The calculation of the cost of debt is relatively easy. The cost of funds raised through debt in the form of debentures or loan from financial institutions can be determined from Eq. 12.1. To apply the formulation of explicit cost of debt, we need data regarding; (i) the net cash proceeds/inflows (the issue price of debentures/amount of loan minus all flotation costs) from specific source of debt,

MEASUREMENT OF SPECIFIC COSTS
The term cost of capital, as a decision criterion, is the overall cost. This is the combined cost of the specific costs associated with specific sources of financing. The cost of the different sources of financing represents the components of the combined cost. The computation of the cost of capital, therefore, involves two steps: (i) the computation of the different elements of the

Explicit and Implicit Costs
The cost of capital can be either explicit or implicit. The distinction between explicit and implicit costs is important from the point of view of the computation of the cost of capital.
The explicit cost of any source of capital is the discount rate that equates the present value of the cash inflows that are incremental to the taking of the financing opportunity with the present val

Assumptions
The theory of cost of capital is based on certain assumptions. A basic assumption of traditional cost of capital analysis is that the firm’s business and financial risks are unaffected by the acceptance and financing of projects. Business measures the variability in operating profits earnings interest anti taxes (EBIT) due to change in sales. If, a firm accepts 3 project that is considerably m

Definition
In operational terms, cost of capital refers to the discount rate that is used in determining the present value of the estimated future cash proceeds and eventually deciding whether the project is worth undertaking or not. In this defined as the minimum rate of return that a firm earn on its investment for the firm to remain unchanged.
The cost of capital is visualized as being composed of several el