Some of the major factors which affect a firm’s cost of capital are:
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1.0 Dependent on the overall country’s economic conditions
- When inflation rate is increasing, cost of doing business is more expensive hence investors and lenders will demand a higher rate of return which results in a higher cost of capital
- When the economy is on its upbeat trend where demand for funds increases and supply of funds are limited or not increasing proportionately to demand then the lenders and financiers increase their lending rate which will also increase a firm’s cost of capital
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2.0 Dependent on the company’s business risk
- The higher a firm’s business risk, the higher the investors’ required rate of return and the cost of capital will also increased.
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3.0 Dependent on the company’s financial risk
- Where a company is highly geared, the lending institutions will consider the firm’s financial risk to be quite high hence would require a higher rate of return from the firm hence increasing the firm’s cost of capital
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4.0 Dependent on the Size of Financing
- Where the firm’s size namely its assets or sales turnover cannot justify the size of financing needs, the lenders will be more cautious and will impose a higher cost of fund which will then increase the company’s cost of capital
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