Cost of capital is affected by controllable as well as uncontrollable factors. Explain.

Cost of capital is affected by both controllable and uncontrollable factors. The same are discussed below: Controllable Factors Affecting Cost of Capital These are the factors that affect the cost of capital and the company has control over them. These factors are as follows: Capital Structure Policy A firm has control over its capital structure, and it targets an optimal capital structure. As more debt is issued, the cost of debt increases, and as more equity is issued, the cost of equity increases. Dividend Policy Given that the firm has control over its payout ratio, the breakpoint of the marginal cost of capital schedule can be changed. The internally generated equity has a lower cost as compared to newly issued equity. As the payout ratio of the company increases, the breakpoint between lower-cost internally generated equity and newly issued equity is lowered. Investment Policy It is assumed that, when making investment decisions, the company is making investments with similar degrees of risk. If a company changes its investment policy relative to its risk, both the cost of debt and cost of equity changes. Uncontrollable Factors Affecting the Cost of Capital These are the factors affecting the cost of capital on which the company has no control: Level of Interest Rates The level of interest rates in the economy affects the cost of debt and, potentially, the cost of equity. For example, when interest rates increase the cost of debt increases, which in turn increases the cost of capital. Tax Rates Tax rates affect thereby after-tax cost of debt. As tax rates increase, the cost of debt decreases, thereby decreasing the cost of capital.