RASHTREEYA SIKSHANA SAMITHI TRUST

R V Institute of Management
CA 17, 26th Main, 36th Cross, 4th T Block Jayanagar, Bangalore- 560041

TOPIC

Discussions on Cost of Capital

Submitted by Neha S D Kavya S Pooja Verma Geetha Submitted to: Mr Gowrisha Faculty RVM

Introduction To Cost Of Capital: Investment decision is major decision for an organization. Under investment decision process, the cost and benefit of prospective projects is analyzed and the best alternative is selected on the basis of the result of analysis. The benchmark of computing present value and comparing the profitability of different investment alternatives is cost of capital. Cost of capital is also known as minimum required rate of return, weighted average cost of capital, cut off rate, hurdle rate, standard return etc. Cost of capital is determined on the basis of component cost of financing and proportion of these sources in capital structure. Objectives of the discussion: To know the practical applicability of the concept of Cost of capital. Significance and importance of cost of capital in companies. Influence of cost of capital in capital budgeting and capital structuring decisions.

 To know the relevance of various aspects considered while calculating cost of capital

Questionnaire
The below Questionnaire was interviewed with the Finance Analyst : Professionals like Finance Manager and

1. Cost of capital and its applications in real time scenario? 2. Significance of cost of capital in capital structuring decisions? 3. Uses of Cost of capital? 4. Influence of Cost of capital in capital budgeting decision? 5. Importance of Time value of money in real time situation? 6. Major elements of Cost of capital? 7. Relevance and compatibility of Weighted average Cost of

capital? 8. Significance of Market Price, Net Proceeds, book value in Cost of capital? 9. Pitfalls in Cost of capital analysis? 10. Recent trends in Cost of capital? 11. Evaluation of Cost of capital in company?

FINANCIAL PROFESSIONALS
1. Ravi Reddy Company Secretary & Senior Manager- Finance Himatsingka Wovens Pvt Ltd Mob: 9980057757 E-mail- Ravi.reddy@himatsingka.com 2. Archana Mallya Deputy Finance Manager Himatsingka Wovens Pvt Ltd E-mail-Archana.mallya@himatsingka.com 3. Shwetha Jain Finance Manager Arkadin Pvt Ltd Mob: 962023539

E-mail- Shwethapalawat@yahoo.com 4. Bhushan Kumar Deputy Finance Manager Mob:9844063145 Himatsingka Wovens Pvt Ltd E-mail-Bhushan.kumar@himatsingka.com 5. Rishi Kahamar Financial Analyst Mob:9739616026 E-mail-Khamarrishi@yahoo.com

Interpretation Based on Discussion 1. Cost of Capital is the price which a Company has
to absorb to generate funds from the market to run its business. The Cost of Capital is differentiated based on the type of Capital, for e.g In case of Loan as a source of Capital- Interest is the Cost . The Cost of Capital is evaluated at the events of fund raising in a Company. 2. As the Capital is available at different costs, the Cost Benefit Analysis of all the sources of Capital should be made while taking capital structuring decisions. The most cost effective source of Capital has to be considered for the Capital Structuring Decisions. 3. Cost of Capital is useful in taking decisions on various projects in company like Capital Structuring,

Capital Expenditure, Loan Rationalisation etc. The proper analysis of Cost of Capital helps the Company to make effective decisions on various areas. It helps the company to achieve better profits also. 4. The Initial and the vital step of Capital Budgeting is Analysis of Cost of Capital. The various sources of Capital available are analysed considering the cost at which it is available and how the source is feasible to the Company. On the effective analysis and its impact on the Company, the Capital Budgeting will be done. . 5. Time Value of Money (TVM) is an important concept in financial management. It can be used to compare investment alternatives and to solve problems involving loans, mortgages, leases, savings, and annuities 6. Cost of capital is made up of two elements: debt and equity. The cost of debt is, in the simplest terms, the amount of interest paid on the debt. The interest cost is historical, but investor expectations may also influence the actual cost (i.e. investors may accept a higher cost in the short term where the long-term gains are better). Other factors may also affect the cost of debt. The interest rate usually includes the risk-free rate plus a risk component, which takes into account the probability of default on the debt.

7. Weighted Average Cost of Capital will give us the correct picture for analysis of Cost of Capital considering the various sources of Capital are available at different price at different time and volume. The cost of capital is volatile in nature and the weighted average helps to take future decision on raising capital. 8. These terms are only applicable in case of Capital available in the form of Investments like Equity, Mutual Funds etc. While determining the Cost of Capital for these kind of sources the Current Market Price of the Investment , the Expected Net Proceeds on Sale of the Investments and the Book Value are evaluated. For a Company to obtain these kind of Sources, the Market Price will determine how much money can be raised.

The Net Proceeds will determine what will be the outflow for the Company if it raises the equity and the Book Value will determine the amount of rights the investor will have in the Company. 9. Cost of capital analysis involves lot of assumptions. For e.g. assumptions of growth rate and future cash flows have to be done which are dependent on various factors from the external market which are not often in the Companys control.

Some factors may have been missed out while calculating the cost of capital which may lead to an ineffective analysis. 10. Most Companies nowadays are going for external sources i.e. like ECBs (External Commercial Borrowings) etc, since the interest rates in the foreign markets are very low compared to the interest rates in India. 11. Companies generally keep a check on the total cost they have incurred to raise the capital. However, where and for what purpose the funds are invested is also equally important. The returns from these investments must be enough at least to meet the weighted cost incurred to generate the funds.

CONCLUSION It was a great experience to get valuable inputs with regard to Cost of Capital from Financial Professions. We came across how to relate the theoretical aspects studied in class with the real time situation and how

important the concept of cost of capital is in major financial decisions of any company.