Cost of Capital Assignment Help




The cost of capital is a term used in the field of financial investment to refer to the cost of a company's funds (both debt and equity), or, from an investor's point of view "the shareholder's required return on a portfolio of all the company's existing securities".[1] It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company.

The cost of capital is the rate of return that capital could be expected to earn in an alternative investment of equivalent risk. If a project is of similar risk to a company's average business activities it is reasonable to use the company's average cost of capital as a basis for the evaluation. A company's securities typically include both debt and equity, one must therefore calculate both the cost of debt and the cost of equity to determine a company's cost of capital. However, a rate of return larger than the cost of capital is usually required.

The cost of debt is relatively simple to calculate, as it is composed of the rate of interest paid. In practice, the interest-rate paid by the company can be modelled as the risk-free rate plus a risk component (risk premium), which itself incorporates a probable rate of default (and amount of recovery given default). For companies with similar risk or credit ratings, the interest rate is largely exogenous.

The cost of equity is more challenging to calculate as equity does not pay a set return to its investors. Similar to the cost of debt, the cost of equity is broadly defined as the risk-weighted projected return required by investors, where the return is largely unknown. The cost of equity is therefore inferred by comparing the investment to other investments (comparable) with similar risk profiles to determine the "market" cost of equity. It is commonly equated using the CAPM formula (below), although articles such as Stulz 1995 question the validity of using a local CAPM versus an international CAPM- also considering whether markets are fully integrated or segmented.

Variable Production Costs:-->

Introduction to variable production costs:

Production costs are the costs of production of a firm. These are money costs or expenses of production. These costs are paid by the producer and are also known as entrepreneur's costs. The production costs are the explicit costs and they enter the account books of the organization. The production costs include

(i) wages to labour

(ii) interest on borrowed capital

(iii) rent or royalty paid to the owners of land or building

(iv) cost of raw materials

(v)  replacement and repair charges of machinery

(vi) depreciation of capital goods and

(vii) normal profits of the firm

Classification of Costs in Variable Production Costs

Costs may be classified as

a) Production costs

b) Selling costs and

c) Other costs

Production costs include material costs, wage cost and interest cost. Selling costs include cost of advertising and Other costs include insurance charges, taxes etc. These accounting costs are important from the producer's point of view and the firm should make sure that the price of the product must cover these costs and normal profits or the firm cannot afford to continue prodcution.

Variable Production Costs Classification

The costs of production can be broadly classified  as fixed production costs and variable production costs. This distinction between fixed and variable production costs is relevant in the short period only. Costs on fixed factors like capital, machinery, land , management etc are fixed costs.

Factors like wages, electricity, raw materical etc are variable. Costs on variable factors of production are termed as variable production costs. Variable costs are those costs that varies  with the level of output and variable costs change with the change in production whereas fixed costs do not change with change in production. The sum of the fixed and variable costs gives the total cost of production.

Labour especially from unorganised sectors comes under variable costs. The firm can take as much as it wants and retrench as much as it wants, when there is no written contract. For example, labour for gardeners of  a huge property, sweepers or watchmen can be paid differently on different days according to the wishes of the employer. Payment to these people are considered a simple decision with no heavy complexities in most cases.

In the long period, however all factors are variable and so all costs are variable. The difference between the fixed and variable costs disappears in the long period.

Community Health:-

Community health refers to health issues concerning a common group of people. It is different from individual health issues in the sense that symptoms, control measures are community oriented. Large part of community health deals with preventive medicines as well as preventive care. Preventive care may include many community facilities involving sanitation, environmental pollution, educating about public hygiene etc.

Major community health services are

  • Immunisation programmes against diseases like cholera, polio, typhoid, jaundice, etc as a preventive measure.
  • Vaccination against diseases like tuberculosis, small pox and measles.
  • Control of mosquito by spraying insecticides and improving sanitation.
  • Awareness programmes about safe healthy drinking water.
  • Checking food adulteration.
  • Testing food and avoiding accidental food poisoning.
  • Educating the people about communicable disease and their method of spread.
  • Awareness programmes about the cause and prevention of diseases like AIDS.
  • Health education programmes at schools, and at adult education units.
  • Educating the people about nutritional imbalances and nutritional need of a body.
  • Educating the people about addictive disorders.
  • Social rehabilitation programmes for victims of drug addiction, AIDS, alcoholism etc.
  • Treatment and rehabilitation programmes for mentally retarded children.

Population as a Resource

Population supplies trained and skilled labour to the country. It is important for the economic growth. If the skilled labour pioneer is properly utilised in industries, it will result in large scale production and the cost of production will fall, the price of products will decline and the market will expand leading to more production.

So trained and skilled labour in the human capital and an increase in human capital contributes to economic growth of a country.

Increase in population also leads to an increase in demand, which is an incentive for increased scale of production and diversification of production pattern, which in turn increases employment opportunities.

Private Investment:-->

Introduction to Define private Investment

When an investor (individual or a corporation) put money in some venture then it is called private investment. When there is an inflow of capital done in a business by a private investor then that investor is said to have made a private investment. With the private investment the investor become eligible to have a share from the profit of the investment in the proportion of capital put by him as well as the investor becomes liable to share the losses made by the investment in the proportion of the capital put by that investor.

Types of Private Investment

1.       Private investment banks –

Private investment banks are the financial institutions that help corporations and Government raise money by acting as an agent or underwriter in issuance of their securities.        

2.       Private placement in equity –

Private placement in equity is said to be made when companies rather going for a public issue asking for subscription of its shares go for a private placements. In private placements a company approaches certain private entities for subscription of its shares to raise capital and this way save the cost of advertising in public. Private placements are generally made at a discounted price.

More Types of Private Investment

 

3.       Private investment by a venture capitalist –

Venture capitalist is also called an Angel investor. These are the investors who invest in a new proposition expecting the venture to be a success. Hence a venture capitalist bears the risk of the venture becoming a failure. The venture capitalist is the one who majorly own a business in its initial phase before it’s going out for public issue of shares.

4.       Private investment in public equity –

Private investment firms, mutual funds and qualified institutional investors purchases stocks in a company at a discount to the current market value of the shares for the purpose of raising capital.

When a layman thinks of a private investment he thinks of an investment like made by a venture capitalist.


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