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Investment Dictionary


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Cost of Capital

 

Capital of every company consists of two parts: equity capital and debt capital (only if company has no financial debts it has only equity capital). Both these capital sources have their costs and this is cost of capital. There are no free capital sources as everything has its price. Think of case debt cost: nobody will give a loan for the company without some interest. Owners of equity capital also do require a return from their investment as well. 


Cost of capital consists of two parts:

  • Cost of equity is a return yield that company’s stockholders are expecting on annual basis from their investment. The best method to calculate cost of equity is CAPM
  • Cost of debt is an interest rate that is paid by the company for its financial liabilities. 

 

Both these capital costs are the main parts in weighted average capital cost (WACC) which is the most representative method to calculate cost of capital precisely.

 






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