Question based on AU Solved Assignment and other course
Answer:
- Historical Cost and Future Cost: Historical cost are those which are calculated on the basis of existing capital structure. Future cost relates to the cost of funds intended to finance the expected project, historical costs are useful for analyzing the existing capital structures. Future costs are widely used in capital budgeting and capital structure designing decisions.
- Specific Cost and Composite Cost: The cost of individual source of capital is referred to as the specific cost and the cost of capital of all the sources combined is termed as composite cost. It is, thus the weighted cost of capital.
- Average Cost and Marginal Cost: The average cost is the average of the various specific costs of the different components of capital structure at a given time. The average cost is relevant for overall investment decision as on enterprise employs a mix of different sources. The marginal cost of capital is that average cost which is concerned with the additional funds raised by the firm. It is very important in capital budgeting decisions. Marginal cost tends to increase proportionately as the amount of debt increases.
- Explicit Cost and Implicit Cost: An explicit cost is the discount rate which equates the present value of cash inflows with the present value of cash outflows. In other words, it is the internal rate of return of cash flows.
Implicit cost is also known as opportunity cost. It may be defined as the rate of return associated with the best investment opportunity for the firm. It is generally said that cost of retained earnings is an opportunity cost in the sense that it is the rate of return at which the shareholders could have invested these funds had they been distributed among them.
