Theoretical Evidence Showing Factors Affecting Cost of Capital
Cost of Capital is considered as the opportunity cost for considering specific aspect for investment. It is generally referred as the rate of return which may be earned by giving the equal amount of money in the different investment with same rate of risk. The cost of capital is regarded as the required rate of return for persuading the investor to consider a given investment. Cost of capital is further determined as the market and the representation of the total degree of the perceived risk incurred by the investors. Cost of capital is pivotal for determining business valuation. The report is aimed to discuss on the theoretical evidence for the chosen factors which affects the cost of capital. The study is further seen to recommend the empirical evidences by using data from “ASX (Australian Securities Exchange)” (Cheynel 2013).
- Current Economic Conditions: In situations where the banks are seen to be growing, the low rate of interest should increase with the sale of stability of the products. The cost of the debt of the company is discerned to decrease with the overall cost of capital. In case of recessionary pressure the financial institute will not reduce the rate of interest due to payment for return to the customers. Each of the loans providing company is seen to be having the stability in the market. The cost of dent is further seen to decrease with an increase in the cost of capital.
- Current Capital Structure: The optimal capital structure has been studies with the various types of different aspects of cost of capital with the weighted average cost. In case a company is not seen to consider the cost of capital, the current capital structure of the study may be included. Current debt equity ratio will effect on the overall cost of capital. In case the debt is seen to be more than the share capital, then in such a case more amount of cost of debt needs to be paid. It has been further seen that in case the share capital is seen to be more then more amount of pay cost of equity and preference share capital needs to be considered (Cao et al.2015).
- Current Dividend Policy: Each company is seen to consider dividend policy. The dividend policy is seen with the total earning and the company which is interested to pay the amount as dividend. Due to this it is important to consider the study of Price-Earnings Ratio (Dividend/EPS). In case there is an increase in the price earning, the cost of retained earnings will reduce and this will result in lesser amount of money and use promotion of business as the main source of fund.
- Getting of New Fund: The new fund requirements of the company will affect the overall cost of capital. In case a company is seen to en requiring a total amount of $ 20 million dollars, the business promotion of the companies will be affected with the higher rate of interest due to increasing risk of the financial institution. Each of the loan providers is seen to be working with the required amount of the credit requirements. The company is further seen to go to the market for acquiring the fund and company will get required amount of the money as per the new market rate. The company needs to follow the new rate of interest which has been seen to base on the various types of the considerations seen to be directly related to return from the company. Except for this, the company needs to get the money as per the new rate in the market. The company needs to follow the new rate associated to the cost of capital and this is seen to decrease with the present cost of the capital rate (Barth, Konchitchki and Landsman 2013).
- Financial and Investment Decisions: The new share capital and the debt is seen to suggest the fund providers for the appropriate usage of the funds. In case the risk is seen to be more then both the shareholders and the creditors will be highly rewarded for the same. The various types of the financial and the investment decisions affecting the cost of capital.
- Current Income Tax Rates: The charging of the interest before tax is seen to affect the cost of capital. In such a case the tax rate will be high and the effect for the same will be reflected in the cost of share capital due to high amount of tax rate.
- Operating and Financing Decision: This factor has been seen to be related to the, decisions made within the company. The different types of the risk result from the decision have been seen to be affected with the financial and the business risk. The business risk has been further identified with the variability in the returns and makes an effect in the investment in the company. The financial risk is seen to increase with the variability in the return in the common stockholders (Krismiaji and Murwani 2016).
- Amount of Financing: This has been identified as the last factor for the determinationof the cost of the The different types financial requirements have been weighed cost of capital increases with the several reasons. For example the securities of the company are seen to be issues with the additional flotation cost and the cost of capital has increased with the issuing of the securities and percentage of the cost of the funds (Boujelbene and Affes 2013).
By analysis of the balance sheet of Wesfarmers has been seen to be affected with the optimised nature of the cost of capital. The effect of cost of capital has been able to affect the company with minimum ROC targets for each division, which are seen to be based on the pre-tax cost of capital. In order satisfy the various types of the factors affecting cost of capital the company is seen to review he ROE targets on regular basis for evaluating the performance in the broader market (Baker and Wurgler 2013).
Another impact of the WACC factor with the financial capital structure is seen with Woolworth. The company has been seen to use financial capital structure is seen with debt financing and equity financing. Some of the main factors affecting the cost of capital for the company has been seen to be related to the use of the various types of the financial decision making tool has been identified with common stock, bond, preferred stock and bills (Li, Ng and Swaminathan 2013).
Another example from Blackmores has shown consistent growth in terms of the various types of the profit which has been seen to be discerned from the revenues over the long-term. The various types of the assumptions for the cost of capital has been affected with the industry average and unlevered beta for the food processing industry. Due to the various types of the increase associated to the cost of capital it has been seen to be discerned that the overall increase in the cost of capital for the company has been seen to be ascertained with the weighted average. The various types of the long terms of capital has been seen to be assumed based on the various types the assumptions which have seen to be associated to proportion of the Asian revenue increase with the decrease in the debt (Hassanain et al. 2013).
The long-term cost of capital is higher than the present cost of capital with 7.12%. It has been further identified that the long-term revenue growth of the company has been discerned as 7.5%. The various factors with the cost of capital has been further seen to be identified with the interest coverage ratio. Hence the different types of the factors are seen to be related with Current Capital Structure, Current Dividend Policy, Getting of New Fund, Financial and Investment Decisions and Current Income Tax Rates (Frank and Shen 2016).
Conclusion
The cost of the debt of the company is discerned to decrease with the overall cost of capital. In case of recessionary pressure the financial institute will not reduce the rate of interest due to payment for return to the customers. Current debt equity ratio will effect on the overall cost of capital. In case the debt is seen to be more than the share capital, then in such a case more amount of cost of debt needs to be paid. The dividend policy is seen with the total earning and the company which is interested to pay the amount as dividend. Due to this it is important to consider the study of Price-Earnings Ratio (Dividend/EPS). By analysis of the balance sheet of Wesfarmers has been seen to be affected with the optimised nature of the cost of capital. The effect of cost of capital has been able to affect the company with minimum ROC targets for each division, which are seen to be based on the pre-tax cost of capital. Blackmores has shown consistent growth in terms of the various types of the profit which has been seen to be discerned from the revenues over the long-term.
Reference
Baker, M. and Wurgler, J. (2013) ‘Do Strict Capital Requirements Raise the Cost of Capital? Banking Regulation and the Low Risk Anomaly’, American Economic Review, 105(5), pp. 315–320. doi: 10.1257/aer.p20151092.
Barth, M. E., Konchitchki, Y. and Landsman, W. R. (2013) ‘Cost of capital and earnings transparency’, Journal of Accounting and Economics, 55(2–3), pp. 206–224. doi: 10.1016/j.jacceco.2013.01.004.
Boujelbene, M. A. and Affes, H. (2013) ‘The impact of intellectual capital disclosure on cost of equity capital: A case of French firms’, Journal of Economics, Finance and Administrative Science, 18(34), pp. 45–53. doi: 10.1016/S2077-1886(13)70022-2.
Cao, Y., Myers, J. N., Myers, L. A. and Omer, T. C. (2015) ‘Company reputation and the cost of equity capital’, Review of Accounting Studies, 20(1), pp. 42–81. doi: 10.1007/s11142-014-9292-9.
Cheynel, E. (2013) ‘A theory of voluntary disclosure and cost of capital’, Review of Accounting Studies, 18(4), pp. 987–1020. doi: 10.1007/s11142-013-9223-1.
Frank, M. Z. and Shen, T. (2016) ‘Investment and the weighted average cost of capital’, Journal of Financial Economics, 119(2), pp. 300–315. doi: 10.1016/j.jfineco.2015.09.001.
Hassanain, M. A., Assaf, S., Al?Ofi, K. and Al?Abdullah, A. (2013) ‘Factors affecting maintenance cost of hospital facilities in Saudi Arabia’, Property Management, 31(4), pp. 297–310. doi: 10.1108/PM-10-2012-0035.
Krismiaji and Murwani, A. S. (2016) ‘Cost of liability capital under shareholders’ monitoring’, Information (Japan), 19(10), pp. 4795–4810.
Li, Y., Ng, D. T. and Swaminathan, B. (2013) ‘Predicting market returns using aggregate implied cost of capital’, Journal of Financial Economics, 110(2), pp. 419–436. doi: 10.1016/j.jfineco.2013.06.006.
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