Use of Methods to Determine the Cost of Capital in Sri Lankan Companies

The aim of the study is to find out the use of methods to determine the cost of capital in Sri Lankan companies. A comprehensive primary survey was conducted of 38 out of 150 financial officers of companies listed on the Colombo Stock Exchange (CSE) in Sri Lanka. Stratified random sampling method was used to select the sample from listed companies in Sri Lanka. Collected data were then analysed by applying mean, percentage analysis and Chi-square test. This study presents the results of survey of 38 financial officers in terms of methods to compute the cost of capital in investment decision making. Results of the study revealed that WACC was the most dominant method to determine the discount rate/cut off rate followed by CAPM and Cost of Debt. Further current study evaluates whether the firm characteristics make differences in the choice of cost of capital methods. Results of the study further revealed that the market capitalization influenced the use of methods to determine the cost of capital in terms of CAPM, Arbitrary Rate, Earnings Yield and Average Historical Rate of Return. There was also significant differences between the types of industry and the use of WACC, CAPM, Cost of Debt and Earnings Yield. However, there was no significant differences of the use of Arbitrary Rate and Average Historical Rate of Return with type of industry. Financial officers with more experience were always and often used WACC and CAPM in comparison with less experience of CFOs. Further, it was implied that in case of Cost of Debt, Arbitrary Rate, Earnings Yield and Average Historical Rate of Return were not affected by experience of financial officers. It was observed that significant differences between the level of educational qualification and use of WACC, Cost of Debt and an Arbitrary Rate.