Page 57 - IMDR MSME BOOK 2021

Managing Finance in Micro, Small & Medium Enterprises
CAPM
Cost of Equity = Risk Free Rate + Beta (Expected market
returns - Risk free rate)
K = R + b (R – R )
f
f
e
m
DDM
Cost of Equity = Dividend after one year * Growth rate
Price Today

K = D * G
e 1
P 0
After arriving at the Cost of Equity and Cost of Debt, the
next stage is to calculate the Weighted Average Cost of
Capital (WACC). The formula is given below:
WACC = Cost of Debt (1-Tax rate) * Weightage of debt +
Cost of Equity * Weightage of equity
Weightage is assigned to Equity and Debt as per their
proportion in capital. Cost of Debt is taken post tax, since
debt provides Interest Tax Shield
Calculation of Cost of Capital is important for the
business as Cost of Capital is the minimum return
expected by the investors from the business. Cost of
capital is used as a Hurdle rate to accept or reject
investment proposals. The expected returns are
compared to the Cost of Capital and then a decision is
taken to invest or not in a prospective project. Accepting
a project offering return below the Cost of Capital means
knowingly investing into loss making business. Hence
Calculation of Cost of Capital is necessary for survival,
continuity, and growth of any business. Not calculating
Cost of Capital may result in investing in some ventures
or projects that are not affordable or rejecting some
protable propositions.