Question

Costs of Capital vs Opportunity Costs

1.What connection do you think exists between costs of capital and "opportunity costs?"

The cost of capital is measured so that you can evaluate the firm’s investment opportunities. In other words, it measures the risks associated with a project. Each project needs to be evaluated for different risk factors. Each of these projects pose a potential opportunity. And each opportunity has a cost that is attached to them. This is how there is a connection between cost of capital and opportunity costs. They are intertwined and are a different measurement of each other.

2.Why do you think firms don't list costs of capital on their financial statements?

I do not believe it is added directly in their financial statements because they technically mention it throughout. The cost of capital is a mixture of debt, stock, and equity. All of which may have different names or are more specified elsewhere in financial statements. A trained eye should be able to piece them together. But adding a direct link may offset numbers. Because someone may be skimming through and make a mathematical mistake. Which could turn into large financial trouble in the future. I believe it would just create a double entry, and become an accounting nightmare.

3. Who receives payment of capital costs?

The weighted average can determine who receives the payment from the cost of capital. If the numbers reach the required rate of return for the firm, then they will receive the payment. But if extra funding is needed they will need to branch out and issue more stocks, which then turns into possible dividends being issued or more money in retained earnings.

Required:

1.What connection do you think exists between costs of capital and "opportunity costs?" Write 50 words.

2.Why do you think firms don't list costs of capital on their financial statements? Write 50 words.

3.Who receives payment of capital costs? Write 50 words.

I've posted some examples above. Please write in your own words and write appropriate answers. Thank You!

Answer 1

1. Cost of capital is an opportunity cost of making a specific investment. It is actually the rate of return that could have been earned by putting the same money into a different investment with equal risk. Hence, the risk is identified with the cost of capital which are related to the equal and potential opportunities which in turn having cost.

2.The firms don't list costs of capital on their financial statements because cost of capital is a mixture of debt, stock, and equity. All these are mentioned in the financial statement with the different name hence there may be situation double entry arises and would leads to the blunders in accounting.

3.There are two conditions in the receiver of payment of capital cost which is based on the weighted average

1. If Weighted Average = required rate of return then company receives the payment and Dividend would be issued to its Shareholders.

2. If Weighted Average != Required Rate of return or lower than this then company need to branch out and issue more stocks.