Distinction between Component cost and Composite cost

Question

Describe briefly Distinction between the term Component cost and Composite cost?

Answer 1

The component cost is the one which comes under the cost of capital and it has three levels:-

i) Return at zero risk level : When there is no risk involved in the project it tells about the expected rate of return

ii) Premium for business risk : This tells about the inconsistency in operating profit because of change in sales.

iii) Premium for financial risk : This indicates about the capital structure risk.

It is the decision whether to purchase services or components from an outsider or not. It requires understanding the cost associated with buying as well as building the components.

Composite Capital is also named the weighted average of component cost of common stock, debt and preference shares. In this each of the components is given a significance on its interest rate, risk study and management loss of control that is employed to compute the composite capital.