Starting any business venture requires capital in the form of cash and sometimes in kind. Capital is necessary to acquire equipment, engage labor, procure raw materials and implement processes necessary for proper management of the business. It is however important to note that the capital to run the business has a cost associated to it. Providers of capital require a return on their capital invested into the business.
Providers of share capital demand dividends based on the performance and growth of the business . Debt providers require fixed interest payment on their funds irrespective of the performance of the business. Debt providers do not have any claim on the surplus profit of the company. The amount of dividends or interest expected by the providers will very much depend on the risk status of the business. The higher the risk the higher the return on capital expected by the providers.
The cost of capital is important as it enables the investors to evaluate whether the business project they want to engage in is viable or not .The return on the project is assessed against the expected return the investor has in mind.
It is important to note that the cost of capital has an impact on the price the goods and services will be sold at. High cost of capital makes the goods and services expensive and in turn affect the competitiveness of the business.