Cost of capital

When the first telephone came out, it had very little value in that hardly anyone used it yet. However, as more and more people started using it, the usefulness grew exponentially.

Determining the Cost of Capital - dummies

The same is true for Bitcoin: the more people who start using and understanding it, the more useful it will become to everyone else. The price of Bitcoin is not the same as its value. Price is determined by the market in which it trades: by means of supply and demand. This is the same way the price of your secondhand car, a bag of apples in the supermarket, an ounce of gold and just about everything else is determined. Traders with bank accounts in our supported countries can trade Bitcoin on the Luno Exchangewhich sets the specific price at a specific determination quotes for a specific market.

Put simply, it is the ongoing interaction between buyers and sellers trading with each other that determines the specific price of Bitcoin and everything else. Price determination definition, when determining price, one must also consider the amount that buyers are currently willing to pay for the future value of a specific item. Equilibrium price is such a price at which the market demand becomes equal to market supply.

If, at any particular price, demand and supply are equal, the buyers and sellers both remain satisfied, for, at the said price, the sellers supply what the buyers demand, and the buyers demand what the sellers supply. None of them is dissatisfied, and so, none of them would want a change in the price.

That is why this price is called the equilibrium price. Monopoly is that market form in which a single producer controls the whole supply of a single commodity which has no close substitute. From this definition there are two points that must be noted:. Thus single firm constitutes the industry.

The distinction between firm and industry disappears under conditions of monopoly. This ensures that there is no rival of the monopolist. Therefore, the cross elasticity of demand between the product of the monopolist and the product of any other producer must be very low. A firm under monopoly faces a downward sloping demand curve or average stephen king essay curve. Further, in monopoly, since average revenue falls as more units of output are sold, the marginal revenue is less than the average revenue.

In other words, under monopoly the MR curve lies below the AR curve. The Equilibrium level in monopoly is that level of output in which marginal revenue equals marginal cost. The producer will continue producer as long as marginal revenue exceeds the marginal cost. At the point where MR is equal to MC the profit will be maximum and beyond this point the producer will stop producing. It can be seen from the diagram that up till OM output, marginal revenue is greater than marginal cost, but beyond OM the marginal revenue is less than marginal cost.

Therefore, the monopolist will be in equilibrium at output OM where marginal revenue is equal to marginal cost and the profits are the greatest. In the short run, the monopolist has to keep an eye on the variable cost, otherwise he will stop producing. In the long run, the monopolist can change the size of plant in response to a change in demand.

In the long run, he will make adjustment in the amount of the factors, fixed and variable, so that MR equals not only to short run MC but also long run MC. The key points of comparison of price determination under Perfect Competition and Monopoly is as below:.

Determination of Cost of Capital: Top 2 Aspects

This is defensive pricing strategy. The company price its products immensely low determination of cost of capital this price is known as entry forestalling priceto retain the monopoly in the market.

It is done to discourage the entry of competitors by presenting the business as unattractive and non-profitable. The peak load method is demand-based pricing, where the companies charge high prices in the peak seasons or period when the demand for the product is quite high. However, in the off-peak time or season when the demand falls, the prices are kept low. It is applied for seasonal product pricing, airline travel pricing, tourism package pricing, etc.

Bundling refers to compiling of two or more products together and selling it as a single product. The company prices the complete bundle at a single price known as the offer price. An organization can either opt for pure bundling, where the products in a bunch are strictly not available individually. Or it may go for a mixed bundling, i. Foreigners may be perceived as being more wealthy than locals and therefore being capable of paying more for goods and services - sometimes this can be even 35 times as much.

Some businesses may offer reduced prices members of some occupations, determination of cost of capital as school teachers see belowpolice and military personnel. In addition to increased sales to the target group, businesses benefit from the resulting positive publicity, leading to increased sales to the general public.

A variety of incentive techniques may be used to increase market share or revenues at the retail level. These include discount coupons, rebates, bulk and quantity pricing, seasonal discounts, and frequent buyer discounts. Many methods exist to incentivize wholesale or industrial buyers. These may be quite targeted, as they are designed to generate specific activity, such as buying more frequently, buying more regularly, buying in bigger quantities, buying new products with established ones, and so on.

They may also be designed to reduce the administrative and finance costs of processing each transaction. Thus, there are bulk discounts, special pricing for long-term commitments, non-peak discounts, discounts on high-demand goods to incentivize buying lower-demand goods, rebates, and many others.

This can help the relations between the firms involved. Gender-based price discrimination is the price determination definition of offering identical or similar services and products to men and women at different prices when the cost of producing the products and services is determination of cost of capital same. With consumer products, differential pricing is usually not based explicitly on the actual gender of the purchaser, but is achieved implicitly by the use of differential packaging, labelling, or colour schemes designed to appeal to male or female consumers.

In many cases, where the product is marketed to make an attractive gift, the gender of the purchaser may be different from that of the end user. Under the Affordable Care Act, health insurance companies are now required to offer the same premium price to all applicants of the same age and geographical locale without regard to gender.

In Europe, motor insurance premiums have historically been higher for men than for women, a practice that the insurance industry attempts to justify on the basis of different levels of risk. The EU has banned this practice; however, there is evidence that it is being replaced by "proxy discrimination", that is, discrimination on the basis of factors that are strongly correlated with gender: for example, charging construction workers more than midwives.

Pharmaceutical companies may charge customers living in wealthier countries a much higher price than for identical drugs in poorer nations, as is the case with the price determination definition of antiretroviral drugs in Africa.

Since the purchasing power of African consumers is much lower, sales would be extremely limited without price discrimination. The ability of pharmaceutical companies to maintain price differences between countries is often either reinforced or hindered by national drugs laws and regulations, or the lack thereof.

Even online sales for non material goods, which do not have to be shipped, may change according to the geographic location of the buyer. Companies will often offer discounted goods and software to students and faculty at school and university levels.

These may be labeled as academic versions, but perform the same as the homeworks south bend indiana price retail software. Academic versions of the most expensive software suites may be free or significantly cheaper than the retail price of standard versions. This also has the characteristics of an "initial offer" - that is, the profits from an academic customer may come partly in the form of future non-academic sales due to vendor lock-in.

Sliding scale fees are when different customers are charged different prices based on their income, which is used as a proxy for their willingness or ability to pay.

For example, some nonprofit law firms charge on a sliding scale based on income and family size. Thus the clients paying a higher price at the top of the fee scale help subsidize the clients at the bottom of the scale.

This differential pricing enables the nonprofit to serve a broader segment of the market than they could if they only set one price. Goods and services for weddings are sometimes priced at a higher rate than identical goods for normal customers.

There are two conditions that must be met if a price discrimination scheme is to work. First the firm must be able to identify market segments by their price elasticity of demand and second the firms must be able to enforce the scheme. Economic literature: papersarticlessoftwarechaptersbooks. Registered: Werner Guth. Endogenous timing can help to derive the time structure of decision making instead of assuming it as exogenously given.

In our study we consider a homogeneous market where, like in the model of Kreps and Scheinkmansellers determine "sales capacities" before prices.In this problem the overall cost of new capital of Rs. In the absence of breakup of net worth in the existing capital structure of the Company, the relative proportion of common stock and retained earnings has been worked out in the following manner:.

Out of this, retained earnings are expected to be Rs. Relative proportion of common stock capital and retained earnings in the capitalisation will then come to 40 per cent and 10 per cent, respectively. Thus, weighted average cost of capital of Modern Tube Company will be 8.

This figure may now be used to compare with internal rate of return of the project, and accept or reject the project on that basis. If the present value approach were used, discount rate of 8.

Weighted cost of capital figure serves as a cut-off point for approval of projects. This would be a wise step in the circumstances that weighted cost of capital is calculated.

In the first instance, considerable amount of uncertainty of proposed investment and the financial uncertainty associated with different sources of capital surround the determination of average cost of capital. The final weighted cost of capital merely represents a guess estimate and it calls for safety margin.

Secondly, estimated rate of return on the capital expenditure project itself contains a great element of uncertainty and safer course of action, therefore, requires upward adjustment of cost of capital. Thirdly, a firm undertakes a project to earn appreciable profit rather than only recovering cost. Fourthly, increased business risk, organisational problems and fear of loss of control through issue of additional common stocks may further lead the financial manager to set cut off rate above the weighted cost of capital.

Active Steel Ltd. The management expects to maintain current dividend payment Rs. The current market price of the share is Rs. Determine the cost of equity capital. Equity shares can be sold to net Rs. Retained driving dangerous essay for the year are estimated to be Rs.

You are required to compute the cost of individual capital components and the overall cost of capital. Synthetics Ltd is considering to float new equity shares. The historical pattern of dividend payments per share for the period is given below:.

Calculate growth rate in dividends and cost of new equity shares. A perusal of compound value table will suggest that Re 1 compounds to Rs. Indian Rubber Industries Ltd. It has equity shares of Rs. What is the weighted average cost of capital? The next year dividend of the Company is expected to be Rs. What is the cost of Equity Shares? Forms of Capital Restructuring. For this reason, cost of capital is also referred to as cut-off rate, target rate, hurdle rate, minimum required rate of return etc.

In management of working capital the cost of capital may be used to calculate the cost of carrying investment in receivables and to evaluate alternative policies regarding receivables.

Determination of cost of capital

It is also used in inventory management also. Cost thesis essay format capital is significant factor in taking dividend decisions. The dividend policy of a firm should be formulated according to the nature of determination quotes firm- whether it is a growth firm, normal firm or declining firm.

However, the nature of the firm is determined by comparing the internal rate of return r and the cost of capital k i. Cost of capital influences the capital structure of a firm. In designing optimum capital determination quotes that is the proportion of debt and equity, due importance is given to the overall or weighted average cost of capital of the firm. The objective of the firm should be to choose such a mix of debt and equity so that the overall cost of capital is minimised.

The concept of cost of capital can be used to evaluate the financial performance of top management. This can be done by comparing the actual profitability of the investment project undertaken by the firm with the overall cost of capital. Cost of capital is measured for different sources of capital structure of a firm. It includes cost of debenture, cost of loan capital, cost of equity share capital, cost of preference share capital, cost of retained earnings etc.

The measurement of cost of capital of different sources of capital structure is discussed:. The capital structure of a firm normally includes the debt capital. You can choose from among three alternatives to determine the cost of internal or equity capital.

Risk premium method: The risk premium method assumes that you incur some additional risk in the investment. For example, when an organization increases its proportion of debt capital more than the optimum level, then it increases its risk factor.

Therefore, the investors feel insecure and their expectations of EPS start increasing, which is the hidden cost related to debt capital. Cost of preference capital is the sum of amount of dividend paid and expenses incurred for raising preference shares. The dividend paid on preference shares is not deducted from tax, as dividend is an appropriation of profit and not considered as an expense.

Determination quotes

Calculating the cost of equity capital is a little difficult as compared to debt capital and preference capital. The main reason is that the equity shareholders do not receive fixed interest or dividend. The dividend on equity shares varies depending upon the profit earned by an organization.

Risk factor also plays an important role in deciding rate determination of cost of capital dividend to be paid on equity capital. Therefore, there are various approaches to calculate cost of equity capital, as shown in Figure According to this approach, investors have certain minimum expectations of receiving dividend even before purchasing equity shares. An investor calculates present market price of the equity shares and their rate of dividend. The dividend price approach can be mathematically calculated by using the following formula:.

However, the dividend price approach is criticized on certain grounds, which are as follows:. Does not take into consideration the appreciation in the value of capital. The dividend price approach is based on the assumption that investors expect some dividend on their shares. It completely ignores the fact that some investors also consider the chances of capital appreciation, which increases the value of their shares.

Ignores the impact of retained earnings, which affect both the market price of shares and the amount of dividend paid.

Price determination definition

For example, determination of cost of capital if an organization keeps major portion of its profit as retained earnings then it would pay low dividend, which may decrease the market price of its shares.

The earnings price ratio approach suggests that cost of equity capital depends upon amount of fixed earnings of an organization. Calculating Cost Basis. Why Is Cost Basis Important? CExamples of Cost Basis. Inherited Stocks and Gifts. Keepin it Simple. The Bottom Line. Key Takeaways Cost basis is the original value or purchase price of an asset or investment for tax purposes. Cost basis is used to calculate the capital gains tax rate, which is the difference between the asset's cost basis and current market price determination definition.

Compare Accounts. The offers that appear in this table are from partnerships from which Investopedia receives compensation. Related Articles. Income Tax Capital Gains Tax Income Tax Do Non-U. Internet Broker? Partner Links. Cost Basis Definition Cost basis is the original value of an asset for tax purposes, adjusted for stock splits, dividends and return of capital distributions.

Holding Period Definition A holding period is the amount of time an investment is held by an investor or the period between the purchase and sale of a security. Carryover Basis Definition Carryover basis is a method for determining the tax basis of an asset when it is transferred from one individual to another. Basis Definition Basis has many meanings in finance, but most frequently refers to the difference between the price and expenses in a transaction when calculating taxes.

In their opinion, future estimated costs are more relevant for decision-making. In the same manner, arguments are given in favour of specific cost and composite cost as well as explicit cost and implicit cost and the marginal cost. The computation of cost of equity capital depends upon the expected rate of return by its investors.

Determination of cost of capital

Milan Bednařík

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