Optimal financial mix is required to minimize the cost of capital : Study

Optimal financial mix is required to minimize the cost of capital says a study published in Finance India, Vol. XXXI No. 1, March 2019 issue. The study entitled “Relationship of Cost of Capital, Cost of Equity Capital, Value of Firm & other Financial Variables : Panel Data & Simultaneous Equation Analysis of Indian Companies” has been completed by Dr. Paramjit Kaur, Professor at University School of Business Punjab University and Dr. Neeti Khullar, Assistant Professor at Desh Bhagat College, Bardwal,
According to the study the companies should consider cost of capital more gravely while taking business decisions based on nature of particular industry to run the firm profitably. Various variables such as size, growth, tangibility, earning per share, dividend payout ratio and value of the firm directly affect the capital structure of the company says the study. The study helps the companies to assess the current scenario on the cost of capital in different selected companies.
According to the study, Businesses in India have to be more cost and quality conscious and allocate their scarce resources rationally, in order to meet the challenges of an increasingly competitive global market. The focus of this study is to find out connect of the firm’s investment decision with financing decision.
The study attempts to empirically examine whether cost of capital is the function of capital structure or remains invariant to the same and also to investigate the relationship between cost of capital, cost of equity capital, value of firm and other financial variables based on Secondary sources of top 500 companies of India on the basis of market capitalization from 2008-10.. The Study indicates that the relationship of cost of capital, cost of equity capital, value of firm and other financial variables in some industries supports the Traditional view i.e. cost of capital is the function of capital structure and affects the value of the firm and in other industries supports the Modigliani and Miller view that cost of capital does not affect the value of firm.
While taking decisions for financial variables in various companies one has to consider number of factors, which lead to increase strategic efficiency and effectiveness of companies.
The analysis based on the findings of Panel data show that cost of equity capital and cost of capital are significantly associated. It also shows with the use of leverage cost of equity decreases. Further tangibility and size are other two important variables, supporting the traditional view that cost capital is function of capital structure and influences the value of firm but all other variable support the MM Hypothesis i.e. cost of capital, capital structure do not affect the market value off firm.
The effect of business risk on corporate capital structure found that there is no single method or techniques that enable a company to hit the optimal capital structure. The findings of the study suggest that different capital structure theories may complement rather than complete each other. DPR and EPS are important variables which affect the financing decision of any company.
The analysis in the study show that the behavior of increasing decreasing occurs because the firms within the same industry differ widely with the economic characteristics with different growth opportunities, different sizes, different asset base structure, and nature of different industries for India in the globalised business environment and the risk preferences of the various investors also differ. The study suggests that measuring and reporting these variables along with appropriate models and also after considering multiple factors will influence the companies to adapt more easily to changing conditions, in changing business financial environment which lead to increase strategic efficiency and effectiveness of companies.
The findings of the study indicate (a) cost of capital and value of firm are significantly inversely related in cement and chemical industry while (b) value of firm is significantly inversely associated with leverage in Metal industry, (c) Cost of capital is positively associated with cost of equity capital in IT industry (d) Value of firm is statistically significant having inverse relationship with leverage during the period of study (e) Size is another important variable significantly associated wit value off firm in Chemical, metal and IT. (f) Tangibility is negatively and positively significantly associated with value of firm and cost of equity in electricity, general engineering chemical, metal and IT ; (g) Size appears positively significant with cost of equity in Metal and in IT and Chemical industry for cross section year 2020, 2009, and 2008 respectably.