Page 56 - IMDR MSME BOOK 2021

Managing Finance in Micro, Small & Medium Enterprises
means provision of capital in expectation of ownership
and protability.

The Cost of Debt is the expectation of the debt providers
in the form of interest. Banks or other nancial
institutions lend money to businesses and it is known as
borrowed capital. Banks expect interest in return for
providing the funds.
Cost of Equity is the expectation of Equity capital
providers in form of prot. As per the Separate entity
concept of Accounting, a business needs to be treated
separately from its owners. For using the money
provided by the investor, the business rewards the
investor in the form of prot. The investor may have
invested money somewhere else and earned some
returns on it, hence he expects the returns equal to his
opportunity cost for not investing into other avenues.
There are many important factors which affect the Cost
of Capital for small businesses. Few of them are:
1. Income Tax rates
2. Demand and availability of money

3. Risk involved
4. Prevailing conditions in market
While is easier to calculate the cost of debt since the
interest rates are xed before the borrowing but arriving
at accurate cost of equity is a challenging task. There are
many methods to calculate cost of equity. Most used
methods to calculate cost of equity are Capital Asset
Pricing Model (CAPM) and Dividend Discount Model
(DDM). Where CAPM uses the Risk-free rate and market
risk factors individual to company, to calculate the Cost
of Equity, DDM uses present and future dividends for the
calculation.