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Dividend decision
Financial Management
Can somebody plz expalin the point ...cost of capital
Answers (5)
Cost of capital is the cost company incurs to obtain funds for its business. If a company wants to get funds through borrowing (which is cheaper) it should give more dividends to its shareholders to reduce the amount of money it has in the bank. But if the company wants to raise funds by selling more shares it's better to use the money it already has in the bank (retain earnings) to avoid diluting the ownership of existing shareholders.
Harshitha Kalidindi
Why should it reduce the amount of money it has in its bank when it is taking debt?
When a company takes loan it has to pay interest on that loan, which is an additional cost of doing business. If the company has extra cash in bank, it can use that money to pay off some loan and reduce the interest it has pay. By reducing the loan , the company can appear more credit worthy to lenders and get a lower interest rate . This can help the company save money and be more profitable.
Harshitha Kalidindi
Why should it reduce the amount of money it has in its bank when it is taking debt?
Retained earnings are not in bank. They may be in a variety of assets / investments - they are re invested back in the business The paragraph means If debt is cheap , then use that to fund business and pay dividends from business surplus If debt is not possible and raising money through fresh issue of shares is required then don't pay dividends and retain money in business and use that money for business purposes here cheap and costly refers to cost of Debt vs . cost of fresh equity issuance
If u take a loan for 1lakhs and pay at 8%.suppose u earn a profit of 20000 then after deducting 8000 u have in ur hand 12000 but u if u take a partner who brings 1 lakhs instead of taking debt both of u get 10000rs each instead of 12000 that's why it's cheaper to get loan instead of capital.but in reality this is not the case for public company where it's cheaper to raise capital rather than opting for loan
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