Cost of Capital

Cost of Capital represents the cost of raising funds for a business, whether through equity, debt, or other sources.

It is a critical metric used by companies to evaluate investment decisions—only projects that generate returns higher than the cost of capital are considered worthwhile.

Types of Cost of Capital

• Cost of Debt: Interest paid on loans or bonds
• Cost of Equity: Expected return demanded by shareholders
• Cost of Preference Shares: Dividend cost (if applicable)

Weighted Average Cost of Capital (WACC)

👉 WACC = (E/V × Cost of Equity) + (D/V × Cost of Debt × (1 – Tax Rate))

Where:

• E = Equity
• D = Debt
• V = Total capital

Why Cost of Capital Matters

• Helps in investment decision-making
• Used in company valuation
• Determines financial efficiency

Interpretation

• High Cost of Capital: Higher risk, expensive funding
• Low Cost of Capital: Cheaper funding, better efficiency

"If a company raises funds at an average cost of 10%, it must earn more than 10% return to create value."