Significance of cost of capital

The cost of capital is significant or important due to following reasons

1) Helps in evaluating financial performance: if the actual profit of the project is more than the expectation and the actual cost of capital than the performance is said to be satisfactory.

2) Helps in determining capital mix in capital structure decisions: it is a rule that there should be a proper debt equity mix and the management has to keep in mind that the optimum capital structure results in maximum value of the firm and minimize the cost of capital.

3) Act as acceptance criteria in capital budgeting: If the present value of expected return from the investment is > or = cost of investment the project may be accepted otherwise rejected.

4) Helps in taking financial decisions: it helps in taking financial decisions like dividend policy, capitalization of profits, of working capital.

These are the significance or importance of cost of capital.

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