Let’s learn weighted average cost of capital for Finance for non-financiers by your own Finance Guru Vishal Thakkar. So, get the most out of it.
Ladies and gentlemen boys and girls welcome back to finance tube your friend and finance guru vishal thakur is here to explain one more complex terminology of finance in very simple words yes friends today we are talking about weighted average cost of capital back now this term sounds very heavy and complicated but believe me it’s not it’s a fancy term use for a very
Simple concept let me explain for a ceo of a large company if he has to do large business he has to get money from somewhere where can he get money from two sources either he can take it from the shareholders or put his own money which is like a single source own money we’ll call it for shareholders money and another is a loan from a bank or a financial institution
So when he gets money from both these sources of course money doesn’t come free of cost he has to pay some cost of money what is this cost of money when you get money from shareholders you have to pay dividend when you get money from a banker you have to pay interest so dividend is cost of equity interest is cost of debt in an overly simplified manner now if we
Were to understand owners or shareholders when they give you money dividend is very little that we pay to them right but their expectation is pretty high why because they are taking risk by investing in big enterprise if they want safety they will put the same money in bank week’s deposit and on small interest and stay happy but because they are buying shares they
Want more returns now how can ceo give more returns to shareholders simple by performance when the company performs the share price of the company goes up on the stock exchange and shareholders get rewarded by increase in value of shares other than dividend so dividend plus capital gains is what is the return for shareholders whereas banker is very happy getting
Low rate of interest on whatever loan he has given however there is a catch to a shareholder or a part owner of the company you can give dividend when you feel like as per your dividend policy if you have profits and if management proposes but to a banker you have to pay interest whether you have profit you don’t have profit it’s a fixed cost now friends weighted
Average cost of capital is calculated as proportion of equity into cost of equity plus proportion of loan into cost of loan what do you mean by this it is very simple let us say we need 100 crores for a new project and we plan to finance it 5050 so 50% own money or shareholders money and 50% load so 50 curves we get from the shareholders 50 crores we get from the
Load now we know that since shareholders expectation is higher than bank interest let us assume cost of equity to be 16% and i called up the bank manager to find out what is the ongoing interest rate he told me 14 percent so 50 per is coming at 16% and other 50% of the money is coming at 14% so what is my weighted average cost of total hundred percent money zero
Point five which is fifty percent proportion of equity into zero point one six which is sixteen percent cost of equity plus zero point five which is proportion of loan taken from bank fifty crores into zero point one four which is fourteen percent cost of loan this equation if you solve it comes to 0.15 or fifteen percent this is the overall cost of money that
You are shelling out in order to get hundred crores for the new project if you increase equity to sixty and debt to forty using the same formula your cost will go up and it will come to fifteen point two percent if you reduce equity from fifty to forty and increase loan from fifty to sixty your cost of capital will come down to fourteen point eight percent so
Basically weighted average cost of capital is the cost of overall money that you get for doing business for whack india’s balance sheet family managed business and other concepts keep watching our channel and if you have not subscribed so far please subscribe now financed you you want to find out what they really mean i have got this paper here which talks about
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Weighted Average Cost of Capital | Finance for Non-Financiers By Finance Tube
