Cost of Capital

Cost of capital

The required return for a capital budgeting project.

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cost of capital

The overall percentage cost of the funds used to finance a firm's assets. Cost of capital is a composite cost of the individual sources of funds including common stock, debt, preferred stock, and retained earnings. The overall cost of capital depends on the cost of each source and the proportion that source represents of all capital used by the firm. The goal of an individual or business is to limit investment to assets that provide a return that is higher than the cost of the capital that was used to finance those assets.

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Cost of Capital

The difference in return between an investment one makes and another that one chose not to make. This may occur in securities trading or in other decisions. For example, if a person has $10,000 to invest and must choose between Stock A and Stock B, the cost of capital is the difference in their returns. If that person invests $10,000 in Stock A and receives a 5% return, while Stock B makes a 7% return, the cost of capital is 2%. One way of conceptualizing the cost of capital is as the amount of money one could have made by making a different investment decision. Many companies calculate the cost of capital when deciding whether to issue stock or a bond, to determine which would be cheaper.

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Cost of Capital

What Does Cost of Capital Mean?

The required rate of return necessary to make a capital budgeting expenditure, such as building a new factory, worthwhile. Cost of capital includes the cost of debt and the cost of equity.

Investopedia explains Cost of Capital

The cost of capital influences the ways in which a company can raise money (through issuing stock or bonds or a mix of the two). Cost of capital is essentially the rate of return that a firm would receive if it invested in a different vehicle with similar risk.

Related Terms:
• Capital Asset Pricing Model—CAPM
• Cost of Debt
• Opportunity Cost
• Risk
• Unlevered Beta