Finance Thesis

CHAPTER 1-INTRODUCTION

1. BACKGROUND OF THE STUDY

This research is important because capital is the base of business, business first has to acquire capital through the cheapest possible source and then carry on production on the basis of cost of capital and the profit margin etc will also be determined on the basis of cost of capital so as to cover it and then earn the profit. In this regard, this research will provide an insight as to how WACC is related to the profitability of the firm. On the basis of this research firms can decide as to how they should arrange capital for themselves so as to minimize the cost and maximize the profit.

In order to estimate overall cost of capital of a company, estimation of cost of each and every component source of capital must be made first. The component sources include

1). Cost of debt after tax Kd (1-T).

2). Cost of common equity Ks.

Now that all the components are known to us, the next step in finding out overall cost of capital is to assess capital structure of a company. Usually in practice, most of the assets of the firms are financed by the mixture of debt and common equity. The combination of cost of capital to finance or firm assets is known as capital structure of the firm. To find out capital structure of a firm, firstly we should find out the percentage of every type of capital sources. Here one another thing which must be kept in mind is a firm optimal capital structure. Optimal capital structure is such a mix of capital which maximizes stocks prices (Ks) and minimizes the WACC or such a mix of capital structure that decreases the cost of capital and therefore increases the value of the firm. The logic behind the importance placed on optimal capital structure; the management has the view that they can increase the total value of the firm by a careful use of financial average. Nowadays it is important for the companies to have a complete knowledge of WACC, it determinants and its impact on overall...