An Introduction to the Cost of Capital

Abstract:     
The Spanish version of this paper can be found at http://ssrn.com/abstract=1997065

This chapter is devoted to the definition and application of the “cost of capital” concept to the valuation of cash flows from different points of view. We present an approach to estimate the cost of debt and general formulations for the cost of equity and the traditional weighted average cost of capital WACC, for the free cash flow, FCF and the non-traditional capital cash flow, CCF. We explain in detail the traditional textbook formula for the WACC with respect to the CCF and FCF. We demonstrate the solution of the circularity problem between the WACC and the value of the cash flow. At the end of the chapter we present some questions to encourage the reader to have further insights to the subject.

Number of Pages in PDF File: 27

Keywords: Cost of capital, weighted average cost of capital, cost of levered equity, Tax Savings

JEL Classification: E47, G12, G31, G30

working papers series