There are many sources available from which finance could be raised. As we all know there is always some of cost of everything similarly for raising finance there is also some cost which a company has to incur. Some of these costs incurred by the company are described below:
It is the return or we can say rate of return which a firm has to pay or need to pay to its equity investors i.e. to shareholders, so that the turnover increases because if equity shareholders will get return they will take decisions for the company in the best manner. The other motive to give return to equity holders is to compensate the risk which they all undertake by investing their capital. As capital is required for growth and expansion by the company that is why owners or equity shareholders expect the return on their investment. Every individual requires something in return after providing services as same as shareholders EPS in the form of dividend like landlords seeks rent, doctors seek fees, teachers seek salary. Cost of equity is little difficult to calculate as compared to the cost of debt because it cannot be estimated as there is no fixed % of return to equity holders unlike debt. According to the finance theory the thing is when the risk of the firm increases or decreases then the cost of equity also changes means it is dependent upon the risk factor. Managers used to make capital budgeting decisions i.e. long term decisions whereas investors make decisions regarding lending and investing. Risk factor is also known as Beta factor.
Cost of Debt/ Debenture
The effective rate at which the company pays to its current creditors or debt is known as cost of debt. This rate is the interest charged on the debt that includes debentures, financial institutions, commercial banks, public deposits etc. These are also known as borrowed fund. If the company can easily arrange borrowed at low rate of interest, then it will prefer more of debt as compared to equity because interest is a deductible expense from the income before paying tax. The interest payment is the basic cost of raising finance through debt. But due to tax advantage the cost of debt should be calculated net of tax benefit.
Cost of Retained Earnings
Retained earnings is the internal source of generating long term finance. It is the amount of capital remained after profit from the net income of the company. The cost of retained earning means the return which the shareholders or the owners of the company require from the company’s common stock, because they have the insecurity that the company is not paying them sufficient amount of dividend whereas it uses to keep the profit with itself.
Cost of Preference Shares
Preference shareholders are the investors those who are preferred over the equity in case of paying dividend. Cost of preference share capital is apparently the dividend. The rate of dividend is fixed, so the preference shareholders get fixed % of dividend in case of profit. Cost of preference shares is annual dividend of these shares upon the market price of the preference stock. The dividend needs to be paid at the end of the financial year for the shares which are held by the preference shareholders.
About the Author
Arpit Goyal is pursuing CA and B.com & also working as an article assistant in Gurgaon. He has an immense interest in Taxation. He loves to use technology to spread knowledge about taxation & accounts.