Question

Critically discuss the effect of the cost of capital on financial decisions.

Answer 1

Cost of capital is needed to determine the overall cost of capital which is required by the firm in order to generate revenue.

It affects the financial decisions to a large impact-

A. If company has a high cost of capital it will be refraining from making long turn investments as it will have a lower rate of return in order to cover the cost of overall capital.

B.cost of capital also help in deciding upon the dividend structure of the company as if the cost of capital is very high for the company it would not be much profitable in order to pay a continuous dividend.

C. It also affect the expansion strategy of a company very large extent.

D.A company which has low cost of capital would always be diversified in comparison to a company which doesn't have a low cost of capital.

E. Cost of capital also determines the flexibility and liquidity available to a company with regards to its decision making abilities.

F. Cost of capital would also affect the the investors preference for Investment as a company with high cost of capital would be less preferred for investment.