Cost of component analysis – A study in indian software industry

The cost of a particular source of finance is the minimum return expected by its suppliers. The expected return depends on the degree of risk assumed by the suppliers. A high degree of risk is assumed by shareholders than debt holders. Debt is a cheaper source of fund than equity capital and preference capital because the interest payment on debt is fixed. Thus, a company borrows capital in order to maximize the profits for its shareholders and it would continue to use this source of finance until the incremental return on it is higher than its incremental cost. Measuring the cost of various sources of funds is a complex subject. In deciding the capital structure of a company, it is very necessary to consider the cost of each source of capital to calculate the overall weighted average cost of capital, which in turn can be used to compare against earnings so as to maximize the wealth of shareholders.