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Cost of Capital - 2 Video Lecture | Crash Course for CA Intermediate

FAQs on Cost of Capital - 2 Video Lecture - Crash Course for CA Intermediate

1. What is the cost of capital and why is it important for businesses?

Ans.The cost of capital refers to the return a company needs to generate in order to justify the risk of investing in its operations. It is crucial for businesses as it serves as a benchmark for evaluating investment opportunities. If the expected return on an investment is greater than the cost of capital, it indicates that the investment is likely to create value for shareholders.

2. How is the cost of equity calculated?

Ans.The cost of equity can be calculated using several methods, with the Capital Asset Pricing Model (CAPM) being one of the most widely used. According to CAPM, the cost of equity is determined by the risk-free rate plus the equity beta multiplied by the market risk premium. The formula is: Cost of Equity = Risk-Free Rate + Beta × (Market Return - Risk-Free Rate).

3. What factors can influence a company's cost of capital?

Ans.A company's cost of capital can be influenced by various factors including market conditions, interest rates, the risk profile of the company, its capital structure, and the overall economic environment. Changes in investor sentiment and adjustments in the perceived risk of the business can also significantly impact the cost of capital.

4. What is the difference between the cost of debt and the cost of equity?

Ans.The cost of debt is the effective rate that a company pays on its borrowed funds, while the cost of equity is the return required by equity investors. The cost of debt is typically lower than the cost of equity because debt holders have a higher claim on assets and cash flows in the event of liquidation. Additionally, interest payments on debt are tax-deductible, which can further reduce the effective cost.

5. How does the weighted average cost of capital (WACC) relate to investment decisions?

Ans.The weighted average cost of capital (WACC) is the average rate of return a company is expected to pay its security holders to finance its assets. It is used as a discount rate for evaluating the net present value (NPV) of investment projects. A project is generally considered acceptable if its return exceeds the WACC, indicating that it will add value to the company.

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Sep 30, 2025 Last updated

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