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.

Computation or methods of calculating cost of capital

The cost of capital can be calculated by different methods these are discussed as below:

(I) Computation of cost by specific source of finance

1) Cost of debt: cost of debt means the interest payable on the debentures. For example, if the company issue Rs 40000, 10% debentures at par in that case before tax cost of debt will be Continue reading “Computation or methods of calculating cost of capital”

Classification of cost

In last article, I have discussed the concept of cost of capital. In this article, we will discuss the classification of cost:

1.) Historical or book or past cost and future cost: historical cost is related to past. It helps in estimation of future cost. While future cost is estimated for future as in financial decisions future cost is more important than the historical cost. Continue reading “Classification of cost”

Cost of capital

The cost of capital is also called hurdle rate or cut off rate. It is the minimum rate of return expected by the investors. The investor’s decision to invest in a particular firm depends upon the cost of capital or cut off rate of that firm which is the minimum rate of return expected by the investors. The firm may use the capital in the form of equity shares, debentures, preference shares and retained earning. In case the firm is unable to achieve the hurdle rate then the market value of the shares will fall. So it is very essential for the firm to achieve minimum rate of return to get wealth maximization.

To conclude cost of capital (KO) is:

• is not a cost rater it is the rate of return from a particular project.
• Minimum rate of return
• Has 3 components – business risk, financial risk, normal rate of return at zero risk level.  KO= B+F+RO

This is the meaning of cost of capital.

4 types of consumer buying behavior

Wants are unlimited and the resources to satisfy these wants are limited. So the consumers think rationally before buying any product. Buying a toothpaste is totally different from buying a luxury car. The more expensive the good is the more information is required by the consumer. There are four types of consumer buying behavior on the basis of buyer involvement while purchasing any product.

 High involvement Low involvement Significant differences between brands Complex buying behavior (motor cycle ) Variety seeking behavior (washing detergent) Few differences between brands Dissonance buying behavior (floor tiles) Habitual buying behavior (toothpaste)

High involvement:- the term means when the consumer is highly involved while buying a product. Generally this situation happens in case of expensive or luxuries goods. Like while buying a diamond necklace a consumer is highly involved.

Low involvement:- this term means when the consumer is not highly involved while buying a product. It happens in case of low price goods. Like while buying toothpaste a consumer is not highly involved.

Significant differences between brands:- it means when there are significant differences between brands.

Few differences between brands:- it means when there are very little differences between brands.

1)      Complex buying behavior:- when the consumer is highly involved in the buying and there is significant differences between brands then it is called complex buying behavior. So in this case the consumer must collect proper information about the product features and the marketer must provide detailed information regarding the product attributes. For eg. Consumer while buying a motor cycle is highly involved in the purchase and has the knowledge about significant differences between brands.

2)      Variety seeking behavior:- in this case consumer involvement is low while buying the product but there are significant differences between brands. Consumers generally buy different products not due to dissatisfaction from the earlier product but due to seek variety. Like every time they buy different washing detergent just for variety. So it is the duty of the marketer to encourage the consumer to buy the product by offering them discounts, free samples and by advertising the product a lot.

3)      Dissonance buying behavior:- here consumer is highly involved in the purchase but there are few differences between brands. Like consumer while buying a floor tiles buy them quickly as there are few differences between brands.

4)      Habitual buying behavior:- in this case there is low involvement of the consumer and there are few differences between brands. The consumer buys the product quickly. For eg. Toothpaste.

These are the types of consumer buying behavior.

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The marketer must understand how consumers make their buying decisions. In some cases it is very difficult to find out who the buyer is and who the user is. There are different roles played by the consumer. So to understand properly consumer buying decision process it is necessary to understand the different roles played by them. They are:

i) INITIATOR:  initiator is the person who brings the idea to buy a product for eg. Son brings the idea to buy a computer.

ii)INFLUENCER: influencer is the person with whom influence person wish tobuy anyproduct. For eg, Son’s friend influences him to buy a computer.

iii)GATEKEEPER: it is the person inside the house who informs that there is no budget to buy it. For example, in this case father says there is no budget to buy the cycle.

iv) DECIDER: it is the person who decides to buy the product like mother decides to buy the computer for her son.

v) BUYER:  now the family member go to the market and buy the product. Like in this case mother and father go to the shop to buy a computer.

vi) USER:  at the end the family uses the computer.

Therefore all these are the different roles played by the consumer in buying decision process.