Question

Answer the following questions based Amazon. Write your response in a separate Microsoft Word document:

o Importance of Cost of Capital: Why is cost of capital important to an organization, and what does it measure?

o Meaning of Calculations: How do organizations calculate various costs, and what do these calculations mean to business?

Answer 1

Cost of Capital:

It is the opportunity cost of investing the cash in different investment instruments. It tells us the returns one can generate investing in the different asset class. It is the mixture of cost of equity and cost of debt.

Cost of capital is very important in taking capital budgeting decisions, if a new project is yeilding more than cost of capital than investment into that project makes sense but if a project is not returing even the cost of capital than the investment is not fruitful.

Cost of Capital = Cost of Equity + Cost of Debt + Cost of Preference Shares

Importance of Cost of Capital:

1) It helps in designing the capital structure which will lead to maximisation of firms return

2) It helps in taking capital budgeting decisions

3) It helps in comparative study of sources of financing

4) Evaluations of financial performance of the company and for different business segments

5) It helps in Financing and Dividend Decisions