C O S T O F

C A P I T A L

PRESENTED BY:
GROUP 1
Agenda
 What is the cost of capital
 Understanding the cost of capital
 Weighted average cost of capital
 Finding the cost of debt
 Finding the cost of equity
 Cost of capital v/s discount rate
 Importance of cost of capital
 Real world examples
What is cost of capital
?
• The cost of capital refers to the required rate of return or the
minimum return that a company must earn on its investments
in order to satisfy its investors and maintain the value of the
company.
• It represents the cost of financing the company’s operations
and projects through a combination of debt and equity.
• In other words, the cost of capital is the average rate of return
that the company needs to generate from its investments to
compensate its providers of capital, such as shareholders and
lenders, for the risk they assume by investing in the company.
• It is a crucial concept in financing management as it helps
determine the feasibility and possibility of investment
opportunities
 Understanding
cost of capital
Understanding the cost of capital is essential for companies when
making investment decisions, evaluating projects, and
determining the most suitable financing options. It serves as a
benchmark for comparing the potential returns of different
investment opportunities and helps management allocate capital
efficiently to maximize shareholder value
The cost of capital consists of two main components:
• Cost of debt: this represents the cost of borrowing money. It is
typically the interest rate that the company pays on its debt
obligation
• Cost of equity: this represents the return required by
shareholders for their investment in the company
 Weighted Average Cost of Capital
WACC is the weighted average of a company’s debt and its equity cost. Weighted Average Cost of Capital
analysis assumes that capital markets (both debt and equity) in any given industry require returns
commensurate with the perceived riskiness of their investments
WACC Formula = (E/V * Ke) + (D/V) * Kd * (1 – TC)
E = Market Value of Equity
V = Total market value of equity & debt

Ke = Cost of Equity
D = Market Value of Debt
Kd = Cost of Debt
TC = Corporate Tax Rate

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 Example for WACC:
The newly formed Gold Company needs to raise $1.5 million in capital to buy an office and the necessary
equipment to run its business. The company raises the first $800,000 by selling stocks. Shareholders demand
a 5% return on their investment, so the cost of equity is 5%.
Gold Company then sells 700 bonds for $1,000 each to raise the remaining $700,000 in capital. The individuals
who purchase those bonds expect a 10% return, so Gold Company's cost of debt is 10%.
Gold Company's total market value is $1.5 million, and its corporate tax rate is 25%. The weighted average
cost of capital can be calculated as:
(done in the board)
Gold Company's weighted average cost of capital is 6.1%.

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2/1/20XX PRESENTATION TITLE 7
Difference between COC & discount rate
Cost of capital
• Definition: the cost of capital is the required
rate of return or the minimum return that a
company needs to earn on its investment to
satisfy the investors and maintain the value of
the company   investors to forgo current consumption and invest
• Application: the cost of capital is used in
capital budgeting or project evaluation, and
investment decision-making, it helps determine
the hurdle rate for accepting or rejecting
projects and assists in evaluating the ROI
• Scope: The cost of capital considers the overall
financing costs of a company, taking into
account both debt and equity financing
Discount rate
• Definition: the discount rate, on the other hand, is
the rate used to discount future cash flows to their
present value. It represents  the opportunity cost of
capital or minimum rate of return required by
• Application: the discount rate is used for
discounted cash flow analysis, net present value
calculations, and other valuation techniques. It
helps determine the present value of future cash
flows and facilities by comparing the value of
different projects of investments
• Scope: the discount rate is specific to a particular
project or investment and reflects the risk
associated with that investment
 Importance of cost of capital
The cost of capital serves as a
benchmark for evaluating the
feasibility and profitability of
investment opportunities. It helps in
comparing the potential returns of
different projects and determining
which projects should be pursued or
rejected .
The cost of capital plays a crucial role in
determining the optimal capital structure for a
company. It helps in making decisions regarding
the mix of debt and equity financing that
minimizes the overall cost of capital and
maximizes the value of the firm. This is important
because the cost of debt and equity financing can
vary and finding the right balance can lead to
lower financing costs
The cost of capital is used in valuation
models to estimate the intrinsic value
of a company. By discounting future
cash flows at the appropriate cost of
capital, the present value of the
company’s expected future earnings
can be calculated, aiding in
determining its overall worth

Making investment Valuation of

Capital budgeting Financing decisions Risk management
decision companies

When making capital budgeting The cost of capital incorporates the risk
decisions, such as evaluating associated with an investment or
whether to undertake new project. By considering the required
projects or invest in long term return to compensate for the risk, it
assets, the cost of capital helps in helps in managing and mitigating risk
assessing the expected return on in financial decision making
investment. It provides a criterion
for accepting or rejecting
projects based on whether they
can generate returns that exceed
the cost of capital
Finding the
cost of
debt
Finding the
cost of
equity
Real world examples
1. ITC
2. Asian Paints
 Cost of Capital of ITC
WACC = WoE * CoE + WoD *CoD* (1- Tax
Rate)
1. Weights – Market value of equity (E) of
ITC is Rs. 5891306.638 million.
Debt – Calculated by adding Short term
Debt and Capital lease Obligation.
March 2023 – ITC’s debt is Rs. 2780.4 million
Weight of equity (WoE) = E/ (E + D) :
5891306.638 / (5891306.638 + 2780.4) =
0.9995
Weight of Debt (WoD) = D / (E + D) :
2780.4 / (5891306.638 + 2780.4) = 0.0005
Cost of Equity (CoE) = 11.38%
Cost of Debt (CoD) = Interest expense /
Book value of Debt
Interest expense = Rs. 432 million
Book value of debt = Rs. 2780.4 million
CoD = 432 / 2780.4 = 15.5373%
Tax Rate = 25.045%
WACC = WoE * CoE + WoD *CoD* (1- Tax
Rate)
WACC = 0.9995 * 11.38% + 15.5373%* (1-
25.045%) = 11.38%
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 Cost of Capital of Asian Paints
1. Weights
Market capitalisation (E) of Asian Paints = Rs. 3252481.608 Million
Book value of debt (D) = 17597.3 million
WoE = E/ (E + D) = 3252481.608 / (3252481.608 + 17597.3) = 0.9946
WoD = D / (E + D) = 17597.3 / (3252481.608 + 17597.3) = 0.0054
Cost of Equity = 13.48%
Cost of Debt = 8.2086%
Average Tax Rate = 26.295%
Cost of Capital (WACC) = E / (E + D) * Cost of Equity + D / (E + D) *Cost of Debt *(1 - Tax
Rate)
WACC = 0.9946 * 13.48% + 0.0054 * 8.2086% * (1 - 26.295%) = 13.44%

2/1/20XX PRESENTATION TITLE 14

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