The Effect of Cost of Capital on the Profitability of Firms Listed at the Nairobi Securities Exchange

Abstract

The execution of financial decisions in business is becoming intricate due to the rapidly changing business environment. Firms need to develop sustainable and immensely proficient financing structures in order to achieve its primary objective, which is profitability. In order to validate theoretical concepts such as how the cost of capital affects profitability, it is essential that empirical studies be conducted. The specific objectives of this study was to establish the effect of the cost of debt and the cost of equity on profitability of firms listed in the Nairobi Securities Exchange. A descriptive research approach was adopted to explain the relationship between the phenomena, while also controlling others factors such as leverage, firm size and liquidity, all of which influence profitability. The study population included 61 firms listed on the NSE, of which secondary data from 50 firms was collected. Descriptive and inferential statistics were used to analyze the predictability, variability and relationship between the study variables. The results generated showed that the regression model was significant in establishing the relationship between the independent variables and dependent variable. The research findings indicated that the cost of debt was statistically significant in affecting profitability due to existence of a strong negative correlation. In contrast, the cost of equity revealed a very weak negative correlation, and thus insignificant in predicting profitability. Among the control variables, leverage exhibited a strong negative correlation to profitability, making it statistically significant. Conversely, firm size and liquidity were discovered to be insignificant in predicting profitability. The study concluded that the overall cost of capital had a relative effect on profitability, with the cost of debt having a significant impact. The study recommended that regulatory measures be encouraged to enable responsible management of debt and its accompanying costs, while also placing importance on further research to determine pertinent factors that affect the relationship between equity costs and profitability.