Cost of Capital

Knowledge Center

Summary, forum, best practices, expert tips and information sources.

29 items • 650.450 visits



What is Cost of Capital? Description

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:

  1. Issuing stock (equity or preferred).

  2. Issuing debt (borrowing from a bank) .

  3. 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:

  1. Cost of Debt

  2. Cost of Preferred Stock

  3. 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.

Cost of Debt calculation + Cost of Preferred Stock calculation

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

Calculation Cost of Equity, Formula

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):

Cost of Capital calculation

Special Interest Group

Cost of Capital Special Interest Group.

Special Interest Group
Special Interest Group (97 members)


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.

topic 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...
Comments3 comments
topic 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...
Comments1 comments
topic 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...
Comments1 comments
topic 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...
Comments1 comments
🔥 What is the Difference Between Cost of Capital and Weighted Average Cost of Capital?
Hello, could you please answer me: What is the difference between the cost of capital and the weighted average cost of capital?...
Comments1 comments

Start a new topic

Start a new topic about the Cost of Capital

Best Practices

The best, top-rated topics about the Cost of Capital. Here you will find the most valuable ideas and practical suggestions.

Expert Tips

Advanced insights about the Cost of Capital. Here you will find professional advices by experts.


Cost of Capital Usage

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.


Calculation of Cost of Capital and its Components

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 for Businesses

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...

Introduction and Summary of Interest Rate Swap

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 ...

Cost of Capital Diagrams

Capital Budgeting
Download and edit this 12manage PowerPoint graphic for limited personal, educational and business use. Republishing in ...

Research Links

Jump to further research sources regarding the Cost of Capital.













Instead of the term (Weighted Average) Cost of Capital you often find its acronym: WACC.

Compare with Cost of Capital: Cost of Equity  |  WACC  |  Capital Asset Pricing Model  |  Internal Rate of Return

Return to Management Hub: Decision-making & Valuation  |  Finance & Investing

More Management Methods, Models and Theory

Special Interest Group

Special Interest Group

Do you know a lot about the Cost of Capital? Become our SIG Leader and gain worldwide recognition as an expert.

About 12manage | Advertising | Link to us / Cite us | Privacy | Suggestions | Terms of Service
© 2023 12manage - The Executive Fast Track. V16.3 - Last updated: 26-9-2023. All names ™ of their owners.

12manage is looking for BA/MBA students. More info.