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BRILLIANT’S Cost of Capital 301

discounting its cash flows by the cost of capi- JUZm Ho$ {b`o H¡$e âbmo H$mo H¡${nQ>b H$s H$m°ñQ> na AmYm{aV
tal. In this sense, the cost of capital is the dV©_mZ _yë` \¡$ŠQ>g© go hr {S>ñH$mCÝQ>> {H$`m OmVm h¡Ÿ& Bg
discount rate used for evaluating the desir- àH$ma H¡${nQ>b H$s H$m°ñQ>, {H$gr ^r BÝdoñQ>_|Q> g§~§Yr
ability of investment project. In the IRR method, àmoOoŠQ> H$s Cn`wŠVVm Ho$ _yë`m§H$Z hoVw Cn`moJ H$s OmZo
the investment project is accepted if it has an dmbr {S>ñH$mCÝQ> aoQ> h¡Ÿ& IRR (BÝQ>aZc aoQ> Am°\$ [aQ>Z©)
internal rate of return greater than the cost of _oWS> _|, H$moB© àmoOoŠQ> V~ ñdrH¥$V {H$`m OmVm h¡ O~
capital. In this context, the cost of capital is the CgH$s BÝQ>aZc aoQ Am°\$ [aQ>Z©, H$m°ñQ> Am°\$ H¡${nQ>c go
minimum required rate of return on the in- A{YH$ hmoŸ& Bg àH$ma H$m°ñQ> Am°\$ H¡${nQ>c, {H$gr BÝdoñQ>_|Q>
vestment project. It is also known as the 'cut àmoOoŠQ> na Amdí`H$ {_{Z__ [aQ>Z© H$m aoQ> h¡Ÿ& Bgo 'H$Q>
off' or the 'target' or the 'hurdle rate'. Am°\$ aoQ>', 'Q>maJoQ> aoQ>' `m 'hS>©c aoQ>' ^r H$hVo h¢Ÿ&
An investment project that provides a `{X {H$gr BÝdoñQ>_|Q> àmoOoŠQ> H$m ZoQ> àoOoÝQ> d¡ë`y
positive NPV when its cash flows are dis- nm°[O{Q>d h¡ Vmo O~ BgHo$ H¡$e âcmo H$mo BgHo$ H¡${nQ>c H$s
counted by the cost of capital, makes a net H$m°ñQ> go {S>ñH$m§CQ> {H$`m OmVm h¡ V~ `h eo`ahmoëS>g© H$s
contribution to the wealth of shareholders. If doëW _| d¥{Õ H$aVm h¡Ÿ& `{X ZoQ> àoOoÝQ> d¡ë`y Oramo h¡ Vmo
the project has zero NPV, it means that its cash
`h Xem©Vm h¡ {H$ àmoOoŠQ> go àmßV hmoZo dmbm [aQ>Z©, H¡${nQ>b
flows have yielded a return just equal to the H$s H$m°ñQ> Ho$ {~ëHw$b ~am~a h¡ VWm Bg àmoOoŠQ> H$mo
cost of capital, and the acceptance or rejection ñdrH$ma H$aZo `m Zm H$aZo go eo`ahmoëS>a H$s doëW na
of the project will not affect the wealth of share-
H$moB© à^md Zht hmoJmŸ& Bg àH$ma H¡${nQ>b H$s H$m°ñQ>,
holders. The cost of capital is the minimum
required rate of return on the investment BÝdoñQ>_|Q> g§~§Yr {ZU©` _| AË`ÝV _hËdnyU© {gÕ hmoVr h¡Ÿ&
project that keeps the present wealth of share- H¡${nQ>b H$s H$m°ñQ> BÝdoñQ> àmoOoŠQ> na [aQ>Z© H$m dh {_{Z__
aoQ> h¡ Omo eo`a hmoëS>g© H$s dV©_mZ doëW H$mo An[adV©Zerc
holders unchanged. Thus, It may be noted that
the cost of capital represents a financial stan- aIVr h¡Ÿ& AV: `h Ü`mZ aIZm Mm{hE {H$ H¡${nQ>b H$s
dard for allocating the firm's funds supplied H$m°ñQ> EH$ \$m`ZopÝe`b ñQ>¡ÝS>S>© h¡ Omo Am°Zg© VWm H«o${S>Q>g©
by owners and creditors, to the various in- Ûmam \$_© H$mo gßcm` {H$E J`o \§$S> H$mo {d{^Þ BÝdoñQ>_|Q>
vestment projects in the most efficient man- àmoOoŠQ> _| g~go à^mdr VarHo$ Ûmam EcmoHo$Q> H$aZo Ho$ {cE
ner. Xem©`m J`m h¡Ÿ&
2. Designing debt policy: The debt policy 2. S>oãQ> nm°{bgr ~ZmZo _| ghm`H$… H$ånZr H$s S>oãQ>
of a firm is significantly influenced by the cost nm°{bgr ^r H¡${nQ>b H$s H$m°ñQ> go grYo à^m{dV hmoVr h¡Ÿ&
consideration. In designing the financing policy, O~ H$moB© H$ånZr AnZr S>oãQ> nm°{bgr V` H$aVr h¡ AWm©V²
that is, proportion of debt and equity in the S>oãQ> VWm BpŠdQ>r Ho$ ~rM AZwnmV {ZYm©[aV H$aVr h¡ Vmo
capital structure, the firm aims at minimising H$ånZr H$m bú` AnZr Hw$b H¡${nQ>b H$s H$m°ñQ> H$mo Ý`yZV_
that overall cost of capital. H$aZm hmoVm h¡Ÿ&
The cost of capital can also be useful in H¡${nQ>b H$s H$m°ñQ>, {H$gr {d{eï> {~ÝXw na \$m`ZopÝg¨J
deciding about the methods of financing at a Ho$ {ZU©` _| ^r ghm`H$ {gÕ hmoVr h¡Ÿ& CXmhaU Ho$ {bE,
point of time. For example, cost may be com-
S>oãQ> `m brO _| VwbZmË_H$ AÜ``Z H$aZo _| `h ghm`H$
pared in choosing between leasing and bor-
rowing. Of course, equally important consid- {gÕ hmoVr h¡Ÿ& {ZpíMV ê$n go {Z`§ÌU Ed§ Omo{I_ H$mo ^r
erations are control and risk. Ü`mZ _| aIZm Amdí`H$ h¡Ÿ&