The Cost of Capital – A Back Up for Learners
44 Pages Posted: 5 Jun 2021 Last revised: 7 Jul 2021
Date Written: May 27, 2021
For investing in profitable ventures, the firms intend to recover the investment made in them. Thus, the determination of the respective cost of capital of a venture can provide a base for making decisions on whether to accept the project profitably. In this context, this paper provides some basic explanations to facilitate the learners of the cost of capital with appropriate exhibits for their easy understanding. This paper primarily attempts to explain and illustrate how the determination of the cost of capital for the investment of equity and debt capitals can be made. Relatively, the use of dividend–price and earnings–price measures, Capital Asset Pricing Model (CAPM), Weighted Average Cost of Capital (WACC), Weighted Marginal Cost of Capital (WMCC), and breaking points of financing sources are also explained meaningfully. Further, in determining the optimum capital budget considering various projects, the use of the investment opportunity curve (IOC) and WMCC is also explained and illustrated. Finally, some of the major problems in determining the cost of capital are presented in brief.
Keywords: Cost of Capital, WACC, WMCC, CAPM, Investment Opportunity Curve, Internal Rate of Return, Hurdle Rate, Opportunity Cost
JEL Classification: G3, G30, G31, G32, H43, M41, O22, Z33
Suggested Citation: Suggested Citation