The cost of capital - -The costs of funds that a company raises and uses, and the return
that investors expect to be paid for putting funds into the
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-The minimum return that a company must make on its own investments, to earn the
cash flows out of which investors can be paid their return.
More on the cost of capital - -The cost of capital to a company is made up of all of the
company's individual sources of finance. This is generally a mix of ordinary shares
(equity), preference shares and debt.
-We need to calculate the costs of these individual sources of finance, which we can
then weight according to their importance in order to calculate a weighted average cost
of capital (WACC). the WACC can then be used as a discount rate for investment
appraisal.
The cost of capital - -The cost of debt capital, both before and after tax considerations
-The difficulties in estimating the equity cost of capital and the key elements that require
informed judgement
-The weighted average cost of capital (WACC) for a company.
Sources of capital - -Equity
-Debt
-Preference shares
Equity capital - Ordinary shares - -Ordinary shares represent the equity share capital of
the firm
-Share in the rising prosperity of a company
-Owners of the firm
-The right to exercise control over the company
-Vote at shareholder meetings
-A right to receive a share of dividends distributed
-Each shareholder entitled to a copy of the annual report
-No agreement between ordinary shareholders and the company that the investor will
receive back the original capital invested.
-What ordinary shareholders receive depends on how well the company is managed.
Advantages of share issues - -Usually there is no obligation to pay dividends
-The capital does not have to be repaid
Disadvantages of share issues - -High cost: direct costs of issue, the return required to
satisfy shareholders.
-Loss of control
-Dividends cannot be used to reduce taxable profit.
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