Good The Cost Of Capital Essay Example

In this topic, the first issue that we discussed was to be introduced to the concept of cost of capital. We learnt that the cost of capital is usually the cost that a firm incurs in order to secure funding, either equity or debt. The cost capital tends to be applied in the area of assessing new projects that a firm intends to undertake. From the investor’s perspective, it is the amount of minimum return they expect to get from providing funds to a firm, thereby setting a certain benchmark which the new project in question must be able to meet. Primarily, the cost of capital can either be the one the firm occur in securing equity as a source financing project or debt as a means of financing various projects that a firm plan undertaking. In this introductory part, we learned that in calculating the cost of capital it is always important to consider the market risks as well as other factors related to the project in order to get a true picture of the actual cost of financing the project. Additionally, most of the firms make use both debt and equity in financing their investment activities. Therefore, in the case where the firm is using the two sources of financing, it should calculate the cost of capital using WACC formula.
The second concept that we studied in this topic is the issue of cost of debt. The cost of debt is the interest that a firm pays for securing a loan from a financial institution or any other credit provider. When calculating the cost of debt, it is important to take into account the issue of risk, default premium, whereby the premium rises when the debt being secured increases. The formula that is used in calculating the cost of debt is (RF+the risk of credit) (1-t), where t represent the firm tax rate and in the case of RF it represent the rate of risk of securing the debt. Another important concept we discussed during the topic was the issue of cost of debt, which usually reflect the amount of return that investors expect to get from a firm by providing funds to a firm. It is calculated using the following formula;
The last concept we discussed was the application of WACC in various financial situations. WACC is usually applied in measuring the cost that a company incurs in securing capital. WACC takes into account both the cost of debt and equity when calculating the cost of securing financing for a company. In practice, the following formula is applied when calculating cost of capital using WACC concept;.
There are a number of things that I did learn from this topic on cost of capital, which I can apply in my life. To start with, I learned that in securing financing, a firm usually incurs some costs; therefore, when I start my business I expect to incur some cost when getting its capital. The cost incurred are usually determined by the risk that investors and creditors perceive the firm to be carrying. Secondly, in calculating the cost of capital it is always important to take into account the risk that is measured using the beta concept. Additionally, I did learn that from the investor’s perspective, the cost of capital reflects the returns they would be expecting from a firm by providing their money to the firm so that it can finance its different investment projects. Therefore, in the future when I will be financing an organization, the cost of capital plays a significant role in determining the ability of the firm to attract potential investors. Lastly, I did learn that the risk associated with the cost of securing debt increase when the amount of debt being secured increases.