Viewpoint of Financial Management: Considerations Underlying Cost of Capital

Abstract

COST OF CAPITAL is in the air. The economists, both quantitative and institutionalist, are analyzing the concept; the lawyers have dealt with it even at the level of the Supreme Court of the United States; the accountants now manifest an interest in it; and financial management must comprehend it in discharging the vital planning function in business enterprise. The planning responsibility is closely interdependent with the analytical, creative, protective, and disclosure functions of management. The very essence of business enterprise is economic in adaptation of productive endeavor to the satisfaction of wants under profit objective; enterprise operates within a framework of law; success or failure in the quest of profit is measured and disclosed in the accounts and accounting statements; the implementation of the enterprise is through capital, in the sense of dollar funds committed to its uses. Accordingly, the managerial viewpoint is properly conditioned by economic, accounting, legal, and financial considerations with substantial reciprocity as well as divergence among the respective associated approaches. The reciprocity and divergence of approach are logically inherent in an analysis of cost of capital. Both cost and capital are terms widely employed in the literature of economics, accounting, law, and finance, and it might be difficult to determine which of the two has the greater diversity of meanings in the arrays of their uses. The concepts of the terms differ not only among these four areas of inquiry, but also within each of the respective fields. However, the implications are less of confusion than of challenge to an understanding of the refinements of thought identifiable with the several lines of its development.