Paper Topic:

Cost of Capital

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Cost of Capital

Capital is one of the most important resources required to run an organization . It comprises of debt and equity . The cost of capital for a firm is a weighted sum of the cost of equity and cost of debt (F Modigliani and M . Miller , 38 . The senior management is charged with the responsibility of maximizing the shareholders wealth among other objectives . To accomplish this , the cost of capital is a major determinant . The board of directors is the overseeing body elected by

br the shareholders . In GE management report and analysis , Debt continues to receive the highest ratings of the major rating agencies such as S br

.The rating is Capital (long -term rating AAA /Aaa :short - term rating A-1 /p-1 . Diversification and risk management strategies enabled the company to grow revenues and earnings to record levels during that challenging time . Global liquidity is providing the company with market opportunities and at the same time reducing risk spreads . Proprietary analytic models are employed to allocate capital to financing activities to identify the primary sources of risk and to measure the amount of risk to take on each product line . This approach enables the company to develop early signals that monitor changes in risk affecting portfolio performance and actively manage the portfolio

Ge and GECS manage a variety of risks including liquidity , credit and market risks

Liquidity risk is the risk of being unable to accommodate liability maturities , fund asset growth and meet contractual obligations through access to funding at reasonable market rates

Credit risk is the risk of financial loss arising from a customer or counterparty failure to meet its contractual obligations while market risk is the potential loss in value of investment and other asset and liability portfolios including financial instruments and residual values of leased assets . This risk is caused by changes in market variables such as interest and currency exchange rates and equity and commodity prices

Management is concerned with cost of capital for various reasons such as

It determines the proper financing mix (Bernheim , B . Douglas , and John B . Shoven . 72 . A firm 's capital structure is made up of equity and debt in different proportions . Through the use of the cost of capital , the management can determine the optimal capital structure

Enjoy tax advantages-this is due to debt issuance . Debt issuance is mostly associated with a certain form of tax savings computed using the prevailing corporate tax rate

Cost of capital is also an indicator of growth and a proper yardstick used by the owners to evaluate the management 's performance

Cost of capital impacts the ability of an organization to borrow or repay its existing debt obligations . This is basically through tax savings on the issuance of debt . It will be cheaper to issue debt as opposed to new equity for the firms recording profits . However at some point , the cost of issuing new debt will be greater than that of issuing new equity due to the default...

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