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Basic Assumptions of Cost of Capital
The Cost of Capital is a dynamic concept affected by a multiplicity of economic and firm factors and assumes the following assumptions relating to taxes and risk:
1) Business Risk: It defines the risk of the inability of the firm to cover its operating costs. This cost is assumed to be unchanged that is the firm's acceptance of a given project does not affect its ability to meet operating costs.
2) Financial Risk: It defines the risk of the inability of the firm to cover the required financial obligations (interests, lease payments or preference dividend) is assumed to be unchanged.
3) After Tax Costs: They are considered applicable. The Cost of Capital is calculated on an after tax basis.
4) Capital Structure: The firm's financial structure is assumed to stay fixed.
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