Financial management - Lecture seven

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 company. -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...