Question

What is cost of capital? What is its significance?Also explain the problems in determination of cost of capital​

Answer 1

Explanation:

Cost of capital is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. Cost of capital is the required rate of return on its investments which belongs to equity, debt and retained earnings. If a firm fails to earn return at the expected rate, the market value of the shares will fall and it will result in the reduction of overall wealth of the shareholders.

5 problems in determination of cost of capital:

i)Conceptual Controversies Regarding the Relationship between the Cost of Capital and the Capital Structure

ii)Historic Cost and Future Cost

iii)Problems in Computation of Cost of Equity

iv)Problems in Computation of Cost of Retained Earnings

v)Problems in Assigning Weights

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