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 cut-
off rate of expenditure
-Solomon Ezra

The cost of capital represents a cut-

off 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 X 100
P
 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.

Formula-
WACC = TOTAL WEIGHTED COST X 100
TOTAL CAPITAL
 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.

Types-
Long 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
 PPT
By
Aaryendr