File Name: cost of capital and capital structure decisions are interrelated .zip
If we know how to measure and price financial risk correctly, we can properly value risky assets. This in turn leads to better allocation of resources in the economy. Investors can do a better job of allocating their savings to various types of risky securities, and managers can better allocate the funds provided by shareholders and creditors among scarce capital resources. Unable to display preview. Download preview PDF. Skip to main content.
It is vitally important that a firm knows how much it pays for the funds used to purchase assets. The cost of capital is an important element, as basic input information in capital investment decision. It also referred to as cut-off-rate, target rate, hurdle rate, minimum required rate of return, standard return and so on. Definition :. Conceptually the cost of Capital may be defines as the minimum rate of return that a firm must earn on its investment for the market value of the firm to remain unchanged.
In theory, these goals are imposed by shareholders through stock market responses to company performance. Consider the way that two numbers—return on investment and rate of sales growth—came to symbolize opposing views of the corporate strategy and environment in Company A. Company A has been a leader in its field for several decades and remains highly regarded by the financial and investment community as profitable, reliable, and conservative. During the s and early s, its CEO knew exactly what the corporate and financial goals should be, and held onto them with unswerving commitment. He saw Company A as an unchallenged leader in technology and product innovation. His was a simple standard of excellence: return on investment. For much of his tenure, he was apparently right.
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One of the most important finance functions is to intelligently allocate capital to long term assets.
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