Explain these a.) Cost of debt ,b.) Cost of preference shares,c.) Cost of equity shares ,d.) Cost of retained earnings
a.) Cost of debt
It is used to measure the cost of capital. This is the first thing which should be calculated in the beginning to find out the cost of capital. It includes both contractual cost and imputed cost. It is defined as the required rate of return that an investment which is debt has to yield to protect the shareholder's interest.
b.) Cost of preference shares
Costs of preference share are also used to calculate the cost of capital and are the fixed cost bearing securities. In this the rate of dividend is fixed in advance when they are issued. It is equal to the ratio of annual dividend income per shares to net proceed. It is not used for taxes and it should not be adjusted for the same. Basically it is larger than the cost of debt.
c.) Cost of equity shares
Cost of equity shares is the hardest job to calculate and it also raises lots of problem while working on its calculations. Its main motive is to enable the management which is to make the decisions in the best interest of the equity holders. There is a certain amount of equity capital which must be earned on projects before raising any equity funds or acceptance of finance for other projects.
d.) Cost of retained earnings
Cost of retained earnings have the opportunity cost associated with it and it can be computed as well without any difficulty. The opportunity cost in this is same as the rate of return of the shareholders which determine the cut off point for the deals. It is also the rate of return which shareholders can get by investing after tax dividends in alternative opportunity.