COST OF CAPITAL, CAPITAL STRUCTURE AND OTHER FUNDAMENTAL ELEMENTS IN FINANCE

The book entitled Cost of Capital, Capital Structure and other Fundamental Elements in Finance is a must read because of areas of its focus. Cost of Capital is a well known concept in finance. A firm’s cost of capital is defined as cost of the funds supplied to it. It is also is described as the required rate of return, since it specifies the minimum necessary rate of return expected by the firm’s investors. The cost of capital is also the rate of return that the suppliers of capital-lenders and owners require as compensation for their contribution of capital. Another way of looking at the cost of capital is that it is the opportunity cost of funds for the suppliers of capital .Under capital budgeting decision process, the cost of capital provides the firm with a basis for choosing among various capital investment projects. It aids decision making before embarking on any project. For example the project’s internal rate of return(IRR) must be greater that the cost of capital for financing it for it to be accepted. Again, for a company to be said to make economic profit , the spread between the return on investment capital(ROIC) and cost of capital . In other words the return on investment capital must be greater than cost of capital. Essentially, we have different types of capitals and their associated costs, For example , we discussed cost of debt, weighted average cost of capital, cost of equity and cost of preferred stock and how to compute them.

Capital structure is another concept that we discussed. This is important because organizations are expected not to finance their operations with equity alone. They are expected to incorporate debt in their capital structure so as to achieve optimal and balanced capital structure. Again, debt provides a debt shield because interest on debt is tax deductible . Specifically, capital structure refers to the specific mix of debt and equity used to finance a company’s assets and operations. From a corporate perspective, equity represents a more expensive, permanent source of capital with greater financial flexibility. Debt, on the other hand, represents a cheaper, finite-to-maturity capital source that legally obligates the company to fixed, promised cash outflows with the need to refinance at some future date at an unknown cost. Here , we discussed also factors affecting capital structure. Another thing that was discussed is capital and financial structure decisions. There is difference between capital structure and financial structure. Capital structure may be defined as the combination of long term debt instruments which include long term loans, debentures, preferred stock(preference shares ) and ordinary shares(including reserves and retained earnings),that constitute a firm’s financing ie capital. The financial structure is a combination of capital structure and current liabilities which include payables and short term loans eg bank overdraft etc. The capital structure is a subset of financial structure that represents the permanent sources of a company’s financing. We also dwelt on mathematical foundation of finance, sensitivity analysis, financial markets and instruments and investment environment.