Borrowing costs, increase

The cost of capital is what it costs a company to borrow money from all sources, such as loans, bonds, and preferred and common stock. It is an important consideration in determining a company s minimum acceptable rate of return on an investment. A company must make more than the cost of capital to pay its debts and make a profit. From profits, a company pays dividends to the stockholders. If a company ignores the cost of capital to increase dividends to the stockholders, then management is not meeting its obligations to pay off outstanding debts. 

Subsequent commentators have argued, however, that secured financing may not reduce, and indeed may increase, the need to monitor the borrower s financial condition. The reason is that if the borrower enters bankruptcy, an automatic stay will freeze the secured creditor s ability to exercise remedies against the collateral and thereby impair the secured creditor s collateral position. As a result, the secured creditor has a significant interest in ensuring the continued viability of the borrower and will incur monitoring costs to further that interest in addition to the costs of monitoring the collateral. 

In order to cut costs, manufacturing firms are increasingly asking for "just-in-time" delivery of raw materials. Laboratories might well borrow this strategy. A quantity of hazardous chemical not ordered is one to which workers are not exposed, for which appropriate storage need not be found, which need not be tracked in an inventory control system, and which will not end up requiring costly disposal when it becomes a waste. 

The discount rate should be equal to the actual rate of interest on long-term loans in the capital market or the average interest rate (cost of capital) paid by the borrower. The discount rate should basically reflect the opportunity cost of capital, which corresponds to the rate of return an investor would obtain if the funds were invested elsewhere with a similar level of risk. The discount rate therefore represents the minimum rate of return acceptable to the investor. When comparing alternative investmenis with different perceived risks, the discount rate can be increased for the more risky project investment so that a comparison can be made between the alternatives. 

The IRR is considerably more difficult to calculate than the NPV without the assistance of a computer, and it represents a sophisticated form of analysis. The IRR is defined as the discount rate that equates the present value of aU cash flows with the initial investment made in a project. The IRR consists essentially of the interest cost or borrowed capital plus any existing profit or loss margin. A project is financially more favorable when the positive difference between IRR and the interest rate charged for borrowing increases. Once all the cash flows have been accounted for over the life of a project, the IRR has to be computed by an iterative procedure. 

High debt ratios will likely prohibit the company from acquiring any new debt financing from lenders. In such cases, it will need to rely on equity sources instead. If they could obtain debt financing, it would likely be more costly to borrow the funds. Lenders will increase the borrowing interest rate to offset the higher risk of non-repayment. 

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