2. DEFINITION
“The cost of capital is the minimum
required rate of earnings or the cut-off
rate of expenditure.”
-Solomon Ezra
It is required rate of return on
invested funds.
3. Significance of cost of capital
Helpful in capital budgeting
Helpful in capital structure decisions
Helpful in evaluating the financial
performance
Basis for other financial decisions
like dividend policy, working capital
decisions, etc.
4. Cost Of Debt (Kd)
Cost Of Preference Shares
(Kp)
Cost Of Equity Shares (Ke)
Cost Of Retained Earnings
5. COST OF DEBENTURES
•It may be defined as the returns expected by
the potential investors of debt securities of the
firm.
•It is Represented by Ke Or Cd.
•It is calculated as before tax cost.
6. CALCULATION OF COST OF
REDEEMABLE DEBT CAPITAL
Kd = i + { MV – NP }/n
{ MV + NP } / 2
Where , i = Interest
MV = Maturity Value
NP = Net Proceeds
n = Number of years to maturity
*100
7. CALCULATION OF COST OF
IRREDEEMABLE DEBT CAPITAL
Kd = [ i / NP ] *100
Where , i = interest
NP = Net Proceeds
8. COST OF PREFERENCE SHARE
CAPITAL
•Cost of preference share capital is in terms of the
fixed rate of dividend.
•It is calculated as after tax cost .
•PREFERENCE SHARE
Redeemable
Preference
Share
Irredeemable
Preference
Share
9. COST OF REDEEMABLE PREFERENCE
SHARE CAPITAL
Kp = PD + ( MV – NP ) / n
( MV + NP ) / 2
*100
Where , PD = Preference Dividend
MV = Market Value
NP = Net Proceeds
10. COST OF IRREDEEMABLE PREFERENCE
SHARE CAPITAL
Kp = ( PD / NP ) * 100
Where , PD = Preference dividend
NP = Net Proceeds
11. COST OF EQUITY
• It is the annual rate of return that an investor
expects to earn when investing in shares of a
company. It is denoted by ke.
•There is no commitment to pay equity
dividend
•It is the sole discretion of the Board of
Directors to pay or not pay dividend or to
decide at what rate the dividend be pay to the
equity shareholders.
12. CALCULATION OF COST OF
EQUITY SHARE CAPITAL
Ke = ( DPS / MPS ) * 100
Ke = cost of equity share capital
DPS = Dividend per share
MPS =Market price per share
DIVIDEND YIELD METHOD :
13. EARNING YIELD METHOD :
Ke = ( EPS / MPS ) *100
Where , Ke = cost of equity share capital
MPS = Market price per share
EPS = Earning per share
DIVIDEND YIELD + GROWTH METHOD :
Ke = [ ( DPS /MPS or NP )*100 ] + G
Where , G = growth rate
NP = Net Proceeds
MPS = Market price per share
DPS = Dividend per share
14. COST OF RETAINED
EARNINGS
•It is the opportunity cost of foregone
dividends. It is represented by kr.
•The earnings to be retained are already
after tax.
•Cost of retained earnings (Kr) = cost of
equity share capital (Ke)
