Plz answer both the question.
Dear student,
Question-1
Cost of capital refers to the monetary sacrifice a company has to make in order to acquire capital or debt for the firm. For example if the firm takes a bank loan for their capital the company would have to pay interest in return. So here interest is the cost of capital for acquiring loan. Determining the cost of capital and financial risk involves the following factors:
1. Cash flow position- Before borrowing money in any form the company must assess the cash flows which will be incurred in future by borrowing debt. While assessing cash flows the company must also set aside some buffer money for any contingencies. For example interest must be calculated before taking loan from bank
2. Interest coverage ratio- Interest coverage ratio is a financial ratio to assess the interest paying capacity of the firm compared with its earnings. It can be calculated using the following formula :
Interest coverage ratio= profit before interest and tax
Interest
3. Cost of debt- A company can reduce its financial risk by reducing its cost of debt. If the cost of debt is lower a company can borrow debt at lower cost and can borrow more money.
4. Tax rate- Debt usually involves payment of interest in return, which results in the benefit of tax exemption. Debt money has the benefit of tax exemption.So if tax rate is higher borrowing debt is a good option to raise capital for business.
5. Flexibility- A firm must always reserve some space for borrowing further debt . If the company borrows debt upon its maximum capacity it may suffer if some emergency occur as borrowing more debt will not be possible.
6. Control- Issuing debt using financial instruments such as debentures will not dilute the ownership of the business.Hence for not diluting the ownership of the firm debt is a good option for the company.
Question-2
Fixed capital simply means investment of capital in long term assets. Fixed capital investment involves investments in projects or contracts which have long term implications for the firm. Factors determining the fixed capital requirements of the company includes:
1. Nature of business- Capital requirements of the firm changes with the mode of operation of the firm.If the firm is a trading company it may require less fixed capital investment and if its a manufacturing company the fixed capital requirements are usually higher.
2. Scale of operations- If the company is large and it has large scale operations in whichever field it may, the capital requirements may be high and if the company deals with small scale operations capital requirements may be low.
3. Technology up gradation- In certain firms assets may become obsolete fast such as an IT company may require frequent up gradation in their computers. Such company's fixed capital requirements will be higher.
4. Growth- If a company is on growth stage it may require higher investments in fixed assets to meet the needs or demands of their product/ service.
5. Diversification- In the new business era companies are diversifying to various industries to cope up with the economy.For example Tata company has both motor vehicles and they also sell salt.With diversification comes need of investing in fixed assets as new business will require new assets.
6. Choice of technique- Some firms may be capital intensive and some labour intensive. Capital intensive firms may require higher investment in fixed assets as the usage of machinery or other equipments will be higher in such companies.
Regards
Question-1
Cost of capital refers to the monetary sacrifice a company has to make in order to acquire capital or debt for the firm. For example if the firm takes a bank loan for their capital the company would have to pay interest in return. So here interest is the cost of capital for acquiring loan. Determining the cost of capital and financial risk involves the following factors:
1. Cash flow position- Before borrowing money in any form the company must assess the cash flows which will be incurred in future by borrowing debt. While assessing cash flows the company must also set aside some buffer money for any contingencies. For example interest must be calculated before taking loan from bank
2. Interest coverage ratio- Interest coverage ratio is a financial ratio to assess the interest paying capacity of the firm compared with its earnings. It can be calculated using the following formula :
Interest coverage ratio= profit before interest and tax
Interest
3. Cost of debt- A company can reduce its financial risk by reducing its cost of debt. If the cost of debt is lower a company can borrow debt at lower cost and can borrow more money.
4. Tax rate- Debt usually involves payment of interest in return, which results in the benefit of tax exemption. Debt money has the benefit of tax exemption.So if tax rate is higher borrowing debt is a good option to raise capital for business.
5. Flexibility- A firm must always reserve some space for borrowing further debt . If the company borrows debt upon its maximum capacity it may suffer if some emergency occur as borrowing more debt will not be possible.
6. Control- Issuing debt using financial instruments such as debentures will not dilute the ownership of the business.Hence for not diluting the ownership of the firm debt is a good option for the company.
Question-2
Fixed capital simply means investment of capital in long term assets. Fixed capital investment involves investments in projects or contracts which have long term implications for the firm. Factors determining the fixed capital requirements of the company includes:
1. Nature of business- Capital requirements of the firm changes with the mode of operation of the firm.If the firm is a trading company it may require less fixed capital investment and if its a manufacturing company the fixed capital requirements are usually higher.
2. Scale of operations- If the company is large and it has large scale operations in whichever field it may, the capital requirements may be high and if the company deals with small scale operations capital requirements may be low.
3. Technology up gradation- In certain firms assets may become obsolete fast such as an IT company may require frequent up gradation in their computers. Such company's fixed capital requirements will be higher.
4. Growth- If a company is on growth stage it may require higher investments in fixed assets to meet the needs or demands of their product/ service.
5. Diversification- In the new business era companies are diversifying to various industries to cope up with the economy.For example Tata company has both motor vehicles and they also sell salt.With diversification comes need of investing in fixed assets as new business will require new assets.
6. Choice of technique- Some firms may be capital intensive and some labour intensive. Capital intensive firms may require higher investment in fixed assets as the usage of machinery or other equipments will be higher in such companies.
Regards