Cost of capital

Cost is the sacrifice we do to acquire any product or service. Cost is not only related to monetary but also to non-monetary values like time and stress taken for acquiring that particular product besides the money we are paying. Cost of capital is the minimum return a person expects from the project proposal. If IRR is less than cost of capital that project proposal should not be selected. Cost of capital is the method used for evaluating the projects.

Importance of capital
Capital is the amount of finances required by the firm to conduct its business operations both in shortrun and long-run. To Promote a business To conduct business operations smoothly To expand and diversify To meet contingencies To pay taxes To pay dividends and interests To replace the assets To wind up To support welfare programmes

Basic Concepts
Capital is of two types Fixed Capital and Working Capital Features of fixed capital--Permanent in nature Profit generation Low liquidity Amount of fixed capital Utilized for promotion and expansion

Working Capital
It is also called as operating costs. It is a financial metric which represents operating liquidity available to the business. Components of working capital are cash, creditors, inventory, debtors . Working should not be low are high. Features: Short life span Smooth flow of operations Easy form of cash Utilized for payment of current expenses

Basic Concepts of Cost

Long-run vs Short-run costs Fixed vs Variable costs Semi-Fixed or Semi-Variable costs Controllable vs Non-controllable costs Opportunity vs Outlay costs Incremental vs Sunk costs Explicit vs Implicit costs Book costs Replacement vs Historical costs Past vs Future costs Separable vs Joint costs Urgent vs Postponable costs

Cost of Debt
The effective rate that a company pays on its current debt. When companies borrow funds from outside or take debt from financial institutions or other resources the interest paid on that amount is called cost of debt. This can be measured in either before- or after-tax returns; however, because interest expense is deductible, the after-tax cost is seen most often. Cost of debt after tax = Interest ( 1- tax rate)

Cost of Equity
Cost of equity (also known as cost of common stock) is the minimum rate of return which a company must generate in order to convince investors to invest in the company's common stock at its current market price. It is alternatively referred to as required rate of return. Cost of equity = (Dividend/ Current market price )+ growth rate

Cost of Preference share

Cost of preference share capital is that part of capital in which we calculate the amount which is payable to preference shareholders in the form of fixed dividend. Cost of preference share capital = Amount of preference dividend / Preference share capital Dividend/ Price- flotation

Sources of finance
Long term Medium term Short term

Long term Sources

Owners capital Share Capital ------- preference share and equity shares Retained capital Long term loans Debentures Government grants and loans

Preference share capital

Cumulative preference share Non-cumulative preference share Participating preference shares Redeemable preference shares Non-redeemable preference shares

Debentures Convertible debentures Partly convertible debentures Non- convertible debentures Secured debentures Partly secured Non-secured Redeemable Non-redeemable

Medium term finance

Bank loans Hire-purchase Leasing or renting Venture capital

Short term Finance

Commercial Paper Bank Overdraft Trade Credit Debt Factoring or Credit Factoring Advance from Customers Short-term deposits from the Customers, Sister companies and outsiders Internal funds

Institutions providing Long-term Finance

Investment Trusts Insurance Companies National Small Industries Corporation ( NSIC) Industrial Finance Corporation of India (IFCI) State Financial Corporation (SFC) Industrial Development Bank of India (IDBI) Small Industries Development Bank of India (SIDBI) State Industrial Development Corporations (SIDCs) State Industrial Infrastructure Corporation (SIIC) Industrial Credit Investment Corporation of India (ICICI)

NSIC
NSIC was set up in 1955 with main objective of promoting small scale industries. To Provide Indigenous and Imported tools, machinery and equipment to the entrepreneurs on purchase of easy terms. To develop prototype of machines for commercial purpose by small units. To train the entrepreneurs on various technical aspects. To underwrite guarantee loans to small units from commercial banks.

Industrial Finance Corporation of India (IFCI)

Set up in 1955 Mainly established to promote large organisations Provide medium and long term Provide direct rupee and foreign currency loans for expansion and diversification. Help to meet specific needs such as equipment finance, equipment credit and in purchasing decisions. Provide guarantee for foreign loans Raises its resources through loans from the RBI, share capital, retained earnings, issue of bonds, loans from government, lines of credit from foreign lending agencies, commercial borrowings in international capital markets

IDBI
Started in 1964 under the act of parliament. Main objective is to address the needs of board-based industries. Providing term finance for fixed asset formation. Balanced industrial growth through development of backward areas , modernisation of specified industries, employment creation, extension and support services in the field of entrepreneurship and capital market development. To provide indirect asistance in the form of discounting , rediscounting long term bills and promisory notes, refinancing of term loans given by SFC , banks and so on. To act as a banker to all the existing financial Institutions.

 To act as a security agent in mortgage, trustee in respect of loans granted by domestic and foreign lenders to companies. To coordinate supplement and monitor the operations of other term lending institutions engaged in the financing , promotion or development of industry. It has been instrumental in developing various institutions such as SIDBI, TCOS, EXIM bank, EDI, CRISIL, SHCIL, SEBI. Venture capital fund is mainly created to encourage commercial applications of Indegiuos technologies, adoptation of imported technologies, development of Innovative products and services holding substantial potential for growth and returns to encourage bankable ventures invovling higher risks.