The cost of capital is very important concept in the financial decision making. Cost of capital is the measurement of the sacrifice made by investors in order to invest with a view to get a fair return in future on his investments as a reward for the postponement of his present needs. On the other hand from the point of view of the firm using the capital, cost of capital is the price paid to the investor for the use of capital provided by him. Thus, cost of capital is reward for the use of capital. The progressive management always likes to consider the importance cost of capital while taking financial decisions as it’s very relevant in the following spheres: Designing the capital structure: The cost of capital is the significant factor in designing a balanced and optimal capital structure of a firm. While designing it, the management has to Continue reading
Financial Management Concepts
Cost of Capital – Meaning, Significance and Components
Investment in capital projects needs funds. These funds are provided by the investors like equity shareholders, preference shareholders, debenture holders, etc in expectation of a minimum return from the firm. The minimum return expected by the investors depends upon the risk perception of the investor as well as on the risk-return characteristics of the firm. This minimum return expected by the investors, which in turn, is the cost of procuring funds for the firm, is termed as the cost of capital of the firm. Thus, the cost of capital of a firm is the minimum rate of return that it must earn on its investments in order to satisfy the expectation of the various categories of investors who have invested in the firm. A firm procures funds from various sources by issuing different securities to finance its projects. Each of these sources of finance entails cost to the firm. Since Continue reading
The Difference Between Agency Theory and Stewardship Theory
Agency Theory An agency correlation as a contractual set-up under which the business owner or the principal engaged a manager or the agent to execute some service on his behalf and may usually entail some decision making exclusively by the agent. The agency theory revolves on the basic proposition about humans, which deals with principals and agents as self-oriented focusing on exploiting their personal advantage. Agency theory described managers as opportunistic by seizing its optimum advantage for his appointment and role as the mover in the firm for its own benefit, at the expense of the principal. Both parties’ goal is to gain that personal advantage in every way possible with the least outlay and expenditure. These expenditures are defined as agency costs. This is the total of cash outflows made by the principal for its organization be it in budget proportions, auditing, or employee honorariums; the expenses incurred Continue reading
Cost Reconciliation Statement
A manufacturing concern may adopt either Integrated Accounting System or Non-Integral Accounting System. Under Integrated Accounting System, only one set of books is maintained to record both costing and financial transaction, therefore, under this system, both financial accounts and cost accounts give similar results. But in Non-Integral Accounting System, separate books are maintained for costing and financial transactions, which may exhibit different results i.e. profits or losses. In other words, when cost accounts and financial accounts are maintained independently by a concern, the profit or loss shown by the cost accounts may not agree with the profit or loss shown by the financial accounts. In this situation, it is needed to reconcile the profits or losses shown differently by cost accounts and financial account by preparing a statement called Cost Reconciliation Statement. A statement which is prepared for reconciling the profit between financial account and cost account is known as Continue reading
Methods of Raising Finance for Business
The methods of financing should be adjusted to the stage or phase of the trade cycle. The total capital shall be raised by different means, or what is sometimes called “geared”, according to the phase of the cycle. Different types of securities may be issued in certain proportions, an what ratio will each type bear to the total capital will depend upon the particular phase. For example, in the beginning of an optimistic expansion, debentures may be offered to good advantage. At a later time, when speculative enthusiasm is strong, shares will yield better returns. During depression short time borrowing can be resorted to, if the credit of the company is good. The financing plan may be adjusted to the conditions of the market an the security market by varying the proportion, rate of yield, term denominations and guaranteed rights of the securities issued. The sources of finance for an Continue reading
Major Participants in Securitization Process
Securitization is the process whereby relatively illiquid financial assets such as mortgages are packaged together and sold off to individual investors. Securitization turns relatively illiquid instruments into quite liquid investments called asset-backed securities. A market maker agrees to create a secondary market by buying and selling the securities. Securitization originated in the mortgage market in the early 1980s, when mortgage loans began to be packaged together and sold off as securities in the secondary market often with government insurance guaranteeing that the principal and interest would be repaid. Securitization became popular because it provides a way of protecting against interest rate risk in an environment of increased interest rate volatility. Securitization offers reduced credit risk because of the pooling of assets. Read More: The Concept of Securitization Process of Securitization Benefits of Securitization The securitization process involves a number of participants. The role of major participants in securitization process are Continue reading