Marginal cost of finance

This is cost of new finances or additional cost a company has to pay to raise and use additional finance is given by:

(Total cost of marginal finance/ Cost of finance (COF)) x 100

Cost of finance may be computed by using the following information like:

            i) Marginal cost of each capital component.

            ii) The weights based upon the amount to increase from each source.

a) Investors generally compute their return basing their figures on cost of investment or market values.

b) Investors purchase their investment on market value and like, the cost of finance to the company should be weighed against expectations based upon the market situation.

c) Investments appreciate in the stock market and like the cost have to be adjusted to reflect that a movement in the value of an investment.

1. Marginal cost of equity

MCE = (D₁ / P₀ -f)*100 (for zero growth firm)

Also cost of equity

K_e =  (D₁ / P₀ -f) (for normal growth firm)

Where: d₁ = expected DPS = d₀(1+g)

           P₀ = current MPS

           f = floation costs

           g = growth rate in equity

1. Cost of preference share capital as:

K_p =(D_P / P₀ -f)*100  

Where: K_p = Cost of preference

           D_p = Dividend per share

           P_o = MPS (Market price per share)

           F   = Flotation costs

2. Cost of debenture

K_d = Int (1-T) / V_d - f

Whereas: K_d = Cost of debt

               Int   = interest

               P_o = Market price for debenture (at discount)

               f   = flotation costs

               t = Tax rate

3. Just like WACC, weighted marginal cost of capital can be computed using:

1. Weighted average cost method
2. Percentage method