Importance Of Cost Of Capital

Corporate Decisions are influenced by a firm’s cost of capital for an aim to reach a stage of profitability and hold the objective of reaching its potential wealth maximum. These are the costs incurred by companies used to finance a firms assets and activities The Cost of Capital is important in analysing the financial aspect of a business by measuring and evaluating business plans and activities. A firms cost of capital is affected by influences from financing, investment and dividend policies.
Projects cost of capital rate of return indicate the riskiness of a project involved where “The firms cost of capital is the overall or average required rate of return on the aggregate of investment projects.” Cost of Capital is a useful method used …show more content…
The costs of capital plays an intergral role in dividend and investment decision making.
Cost of capital is the expected rate of return attracting funds to a particular investment or asset, also known as the opportunity cost. The cost of capital comes from the marketplace where investors asses the risk or a particular asset representing the investors or firms expectations based on the market data. Cost of capital is market driven and forward based through focus on the expected return from the market for an asset, compared effectively with the market value. The cost of capital links the expected future returns of an asset with its present value.
Cost of Capital applications are mainly used for valuations for any prospective decisions made on projects or asset investments. Net Cash flow is used for discounting or capitalising a project or investments valuation and through use of the discount rate, returns are discounted by using the present value to the specific asset investment or project. Cost of Capital is used for capital budgeting purposes, accompanied with the internal rate of return. The Cost of capital is compared with the internal rate of return for different projects, these projects are accepted when the internal rate exceeds the cost of …show more content…
The risk adjusted cost of capital gives the risk of the project as the greater the risk is equal to the higher cost of capital. The CAPM is used by firms estimating the cost of capital and the NPV method assumes that cash flows will be reinvested for the firm’s cost of capital. Reinvesting the cost of capital is a closer approximate to the actual figures. A projects required rate of return can be equal to the firms cost of capital but the risk is adjusted if the risk of the project is higher or lower than the firms risk through the use of