Cost of Capital
Cost of Capital alludes to the cost of funds (counting debt and equity) utilized by a business to finance its business. It likewise alludes to the expected return on money invested in a business by investors who purchase stock, as well as debt holders who purchase bonds and loan money to the business.
Features
- Cost of capital incorporates the cost of both equity and debt, weighted by the company's preferred or existing capital structure. This is known as the weighted average cost of capital (WACC).
- A company's investment choices for new projects ought to continuously generate a return that surpasses the association's cost of the capital used to finance the project. If not, the project won't generate a return for investors.
- Cost of capital addresses the return a company needs to accomplish to legitimize the cost of a capital project, like purchasing new equipment or developing another building.
FAQ
What Is the Difference Between the Cost of Capital and the Discount Rate?
The two terms are frequently utilized conversely, however there is a difference. In business, cost of capital still up in the air by the accounting department. It is a somewhat clear calculation of the breakeven point for the project. The management team utilizes that calculation to decide the discount rate, or hurdle rate, of the project. That is, they conclude whether the project can deliver a sufficient return to repay its costs as well as reward the company's shareholders.
Why Is Cost of Capital Important?
Most businesses endeavor to develop and extend. There might be numerous options: extend a factory, buy out a rival, build a new, greater factory. Before the company settles on any of these options, it decides the cost of capital for each proposed project. This shows what amount of time it will require for the project to repay what it cost, and the amount it will return from here on out. Such projections are dependably gauges, of course. Yet, the company must follow a reasonable methodology to pick between its options.
