Q. Trouble in Determination of Cost of Capital?
Trouble in Determination of Cost of Capital:-
1. Historic Cost as well as Future Cost: - One main problem in the determination of cost of capital arises due to difference of opinion regarding the concept of cost itself. It is dispute that book costs are historic costs as well as the calculation of cost of capital on the basis of such costs is irrelevant for decision making.
2. Problems in calculation of Cost of Equity: - The calculation of cost of equity capital depends upon the rate of return expected by equity shareholders. But it is extremely difficult to assess the expectation of equity shareholders for the reason that there are many factors which influence their expectations.
3. Problems in calculation of cost of retained earnings: - Occasionally it may appear that retained earnings are free of cost because they haven't been raised from outside.
4. Problems in conveying Weights: - Weights have to be assigned to a variety of sources of finance to compute the weighted average cost of capital. The choice of utilizing the book value weights or market value weights places another problem in the calculation of cost of capital.