The Cost of Capital is the amount, expressed as an
annual percentage, that a firm must pay to obtain adequate funds.

Firms finance their operations by three mechanisms:

Issuing stock (equity or preferred).

Issuing debt (borrowing from a bank) .

Reinvesting prior earnings (internal financing).

The significance to a business of its cost of capital is that
it has to ensure that all investments it makes yield a
Return, which is at least equal to the cost
of capital. The return on capital must be greater than the cost of capital.

Calculation of Cost of Capital. Formula

The Cost of Capital is the weighted sum of the:

Cost of Debt

Cost of Preferred Stock

Cost of Equity

To derive the Cost of Capital, each of its 3 components must
be calculated first.

To calculate the Cost of Debt, multiply the interest
expense associated with the debt by the inverse of the tax rate percentage,
and divide the result by the amount outstanding. Be sure to include any transactional
fees in the denominator (acquisition fees, premiums, discounts).

To calculate the Cost of Preferred Stock, simply divide
interest expense by the amount of preferred stock.

Visit the following page for more details on calculating
the Cost of Equity.

Now that all of its three components have been calculated,
they can be combined on a weighted average basis to derive the blended cost
of capital for a firm.

This is done by multiplying the cost of each component by
the amount of outstanding funding associated with it (see figure 2):

Forum discussions about the Cost of Capital. Below you can ask a question about this topic, share your experiences, report a new development, or explain something.

What are the Effects of Inflation for Companies?
What is the impact of increasing inflation on companies? I've already found 4 categories:
I. Effect on Liabilities
Higher inflation has POSITIVE effects in the liabilities side of the balance shee...

Analysis of Capital Investments
Should a firm accept the independent projects described below? Why or why not?
A) the firm´s cost of capital is 10 % and the estimated internal rate of return of the project is 11 %.
B) a capital in...

Cost of retained earnings
My question is how to calculate cost of capital in case a company has its funds only through equity shares & its reserves?
Then how to calculate cost of retained earnings (reserves). As it is a major...

Cost of Capital ( Equity Only)
We recently were required to calculate a charge in order to determine the economic value added. We used CAPM to calculate the cost of equity. We are a debt free company. Since we are not a listed comp...

Cost of Capital application The cost of capital is applied for Capital Budgeting objectives. Under the Net Present Value method (NPV), the cost of c...

Information Sources

Various sources of information regarding the Cost of Capital. Here you will find powerpoints, videos, news, etc. to use in your own lectures and workshops.

Cost of Capital Calculation, Trainings, Workshops This superb explanation establishes a solid initial understanding of:
- Cost of Capital
- Cost of Equity
- Cost of De...

Corporate Valuation, Book Value, Market Value, Intrinsic Value, Fundamental Value, M&A, VBM, Fundamental Investing Presentation that elaborates on corporate valuation, including the following sections:
1. Three types of value:
- Book...

Initial Understanding of Interest Rate Swap Explanation of Base Rate Swaps.
A swap is an instrument that allows you to exchange a variable rate of a loan (that is ...