Cost of

Capital

Introduction
Thecost

ofcapitalis the cost of a

company's funds
(bothdebtandequity)or,from an
investor's point of view "the
expected return on a portfolio of all
the company's existing securities".
It is used to evaluate new projects
of a company as it is the minimum
return that investors expect for
providing capital to the company,
thus setting a benchmark that a
new project has to meet.

Definition
The

cost of capital is the minimum

required rate of earnings or the cutoff rate of expenditure
-Solomon Ezra

The

cost of capital represents a cutoff rate for the allocation of capital

to investments of projects. It is the
rate of return on a project that will
leave unchanged the market price of
the stock.
-James C.

What does cost of capital

mean?
The cost of capital is the
rate of return that capital
could be expected to earn
in an alternative
investment of equivalent
risk.
Cost

of capital includes

Importance of Cost of
Capital

The

concept of cost of capital

is crucial in financial
management. Like any other
source of finance has a cost
and cannot, therefore, be
used in the most effective
manner unless that cost can
be accurately determined
and taken into account.

TYPES OF COST OF
CAPITAL
1)COST OF EQUITY (Ke)
2)COST OF DEBT (Kd)
3)COST OF PREFRENCE
SHARES (Kp)
4)COST OF RETAINED

Cost of Equity
The

annual rate of return that

an investor expects to earn
when investing in shares of a
company is known as the cost
of equity.It is denoted by Ke.

Formula-

Ke =

D
P

X 100

Cost of Debt

Cost

of debt capital is
associated with the amount of
interest that is paid on currently
outstanding debts. It is denoted
by Kd.

Formula
Cost of Debt = I (1 - TAX)
I = Interest

Cost of Preference shares

The

preference share capital is

different from equity share capital on
account of two basic features :
1)the preference shares are entitled to
receive dividends at a fixed rate in
priority over equity shares.
2)in case of liquidation of the
company ,the preference shareholders
will get the capital repayment in
priority over the distribution among
the equity share holders .
It is denoted by Kp.

Cost of Retained Earnings

In

accounting,
retained earnings
refers to the portion
of net income which
is retained by the
corporation rather
than distributed to its

Weighted Average Cost of

Capital
A

calculation of a firm's cost

of capital in which each
category of capital is
proportionately weighted.

FormulaWACC

TOTAL WEIGHTED COST

TOTAL CAPITAL

100

Capital Structure
Capital

structure refers
to the way a corporation
finances its assets
through some
combination of equity,
debt, or hybrid
securities. A firm's

Debt financing
Debt

financing is basically
money that you borrow to
run your business.

TypesLong

term debt financing .

Short term debt financing.

Capital Budgeting
Capital

budgeting is the
planning process used to
determine whether a
firm's long term
investments such as new
machinery, replacement
machinery, new plants,
new products, and

Pay back period

The

length of time required

to recover the cost of an
investment.

Formula-

Return On New
Invested Capital
A

calculation
used,eitherbya firm
orinvestors, to
determine the
amount of return that
a firm couldearn on

Risk
The

chance that an
investment's actual
returnwill
bedifferentthan
expected. This
includes the

Weighted Average
Cost of Equity
A way to calculate the
cost of a company's
equitythat gives
different weight to
different aspects of
the equities.

Case study on nike

PPT
By
Aaryendr