IGNOU : M.COM : MCO 7 : UNIT 5 : Q - 3. What are the importance of Cost of Capital ?

Ans. Importance of Cost of Capital

The determination of the firm's cost of capital is important from the point of view of the following :

i) It is the basis of appraising new capital expenditure proposals. This gives the acceptance / rejection criterion for capital expenditure projects.

ii) The finance manager must raise capital from different sources in a way that it optimizes the risk and cost factors. The source of funds which have less cost involve high risk. Cost of capital helps the managers in determining the optimal capital structure.

iii) It is the basis for evaluating the financial performance of top management.

iv) It helps in formulating appropriate dividend policy.

v) It also helps the organization in developing an appropriate working capital policy.