The concept of cost of capital budgeting is

concerned with cost of capital . The

concept of cost of capital is significant not
only for capital budgeting it is also
indispensable in other areas of financial
management.
In operational terms the cost of capital is the
rate of return of a firm must earn on its
investments so that market value of the
concern remain unchanged.
O Cost of capital is the minimum required
rate of earning or the cut off rate for
capital expenditure.µ
Soloman Ezra

i) Designing the optimal Capital structure

ii) Assisting in investment decisions

iii) Helpful in evaluation of expansion

projects

iv) Rational allocation of national

resources
r. Debts
2. Preference share capital
3. Equity Share capital
4. Retained earning
5. Depreciation fund
6. Short ² term credit
 A company obtains debts generally by
issue of debentures . Usually rate of
interest payable on debenture is related
as its cost but it is not correct .
types
r. Irredeemable
2. Redeemable
after tax= Before tax
r tax rate)
m Analogous to LT Debt
m Cost of Pref. shares may be defined as the
minimum rate of return that must be earned
on the preference share financed
investment.
m This rate is obtained by dividing the DPS by
the current market price per share.
m u
º
DPS  
   
 

Kp= x r

   
  
MPS
m Most difficult to compute.
m No fixed dividend distributed
m There are two approaches for
calculationº
 Dividend Approach
 Earnings Approach
Ô
Ô Ô

[ All that the Shareholders get is only
dividends and so Cost of Equity shares is
equal to current dividend compared
current market price.
m u

DPS
Ke =  r


MPS  
   
 
  
   

[Ä   !"#$$

# $% $ & $
$ $%' $ $%% (
$
 DPS
Ke = g
MPS
r )
 
    
  
   
&' $ 

uu$$
$
II. 
Ô'

 In this approach, total earnings and not
total dividends that are taken into account.
 This approach is useful in two waysº
Even undistributed profits belong to
equity shareholders
Market Price is influenced more by
earnings & not by dividend alone
m Retained Earnings also incurs some cost,
i.e., Opportunity Cost.
m The minimum cost of Retained Earnings
should be equal to Ke.
m Suitable adjustments must be made for
individual tax and Brokerage charges.
u

)
) *+,-.*+,Ä.
[ Once the cost of individual capital
components are calculated, then
combined COC can be calculated
following
+ the 3 steps
/ discussed
0 earlier.
1
 
 uu

-Ô  u-
-3 Ô'- -
u- -*2.  *2. */"04+55.*2.
Debentures 4

4.

r.6

Equity Shares 4
r4.

5.6

Preference Shares r
r
.

r.


Retained Earnings r
r
.

r.


r

6
/5* .
m Ñork Measurement is a term which covers
several different ways of finding out how
long a job or part of a job should take to
complete. It can be defined as the
systematic determination, through the use
of various techniques, of the amount of
effective physical and mental work in terms
of à
 in a specified task. The work
units usually are given in  ( 
or  $ .
 -

m At the "precision" end of the scale is a group of methods known as predetermined motion time systems
that use measurement units in ten thousandths

.


r) of a minute or hundred thousandths of an hour
.

m The resulting standard times can be used directly, for very short cycle work of around one minute total
duration such as small assembly work. However, they often are used to generate regularly used basic
tasks such using assembling or disassembling nuts and bolts, using a screwdriver and similar. Tasks of this
type are filed as  $ !,7.

(&

m At the other end of the scale

long cycle and project work) we need something which is quick to use.
Such a method is (&. This can exist in three main forms.
m j

   relies on the experience and judgement of the estimator. It is just of case of
weighing up the work content and, using this experience, stating a probable time for completion, such
as "this job will take about eight days to complete".
m 2  
   This is a form of range estimating and requires a knowledge of the work.
Estimators may not feel comfortable with overall, analytical estimates upon which may depend the
outlay of a great deal of money. They often prefer giving a range estimate such as "this job should
take between r2 weeks and r4 weeks to complete", which provides a safety net should things go
wrong. Such ranges are not just picked upon at random but are statistically calculated and based on
probability theory.
m 2 
    This is another example of range estimating. Again, estimators rely on
experience of the work in order to produce estimates. This experience can be augmented by the
provision of each time range with a few typical, descriptive, jobs that would guide estimators to the
most appropriate range. The estimator would compare the work to be estimated with those in the
various ranges until the most appropriate fit is found.
-(&

m The intermediate method between the two groups above, is  the work in some
way, usually with a stop watch or computerised electronic study board. This method is
 $# in that the job must be seen in action in order to be timed whereas the
other methods are # $# and can be used for timing jobs before they start.
m The observer times each element of the work and obtains times that the observed
operator takes to do the elements. Each timing is  
rated) by the pace at which
the operator was working as assessed by the observer. This produces basic times for the
elements and hence the whole job, which are independent of the operator and can
be used as the time for a trained, experienced worker to carry out the same elements.
m Another method of assessing the work is using activity sampling and rated activity
sampling. This is a method based on the observer making snap observations at random
or systematic sample times, observing what the operator is
or operators are) doing at
the times of those observations .
$
m A most useful method for standard or synthetic data banks of job or element times is
using computer models of the jobs. These are generated as mathematical formulae in
which the observed data are inserted to compile a time for completion of the task or
project. It is a useful method for recycling time standards for elements of basic work over
and over again, only changing the values of the variables to suit each project.