The Cost of Capital is a Critical
Element in Business Decisions
A Report submitted in partial fulfilment of the requirements for the award of Master of Science of the Loughborough University.
This paper discusses the issue of whether the Cost of Capital is a critical element in business decisions through the topics of Capital Structure and the effects of the Cost of Capital on a company's competitiveness.
Through the use of both qualitative and quantitative data, this paper discusses the two main perspectives on the Cost of Capital, that it is or is not a critical element in business decisions, as well as the advantages and disadvantages of use of debt and equity within capital structures and the views of the effects of the Cost of Capital on companies' competitiveness.
Investment in capital assets naturally requires some form of finance, and "since the method of finance that is employed by a particular firm defines their cost of capital (which in turn affects the amount of investment undertaken), it is obvious that the investment and finance decisions of the firm are inexorably linked" (Brewster, 1999).
The degree to which the Cost of Capital is critical in business decisions will be dependant upon the characteristics of each firm. While theory promotes the concept that the cost of capital is critical in business decisions, in practice it is clear that the firms that enjoy the greatest success in the long-run are those with an entrepreneurial outlook that are willing to substitute concerns for the cost of capital with taking greater risks in their financing decisions in order to achieve continued innovation and success. While these are often the firms that are heavily geared towards R&D and the goal of out-innovating their competitors, the understanding that the cost of capital is...