COST OF CAPITAL DEFINED
Cost of capital is defined as the rate of return that is necessary to maintain the market value of the
firm (or price of the firm’s stock). Managers must know the cost of capital, often called the minimum
required rate of return in:
(1) making capital budgeting decisions;
(2) helping to establish the optimal
capital structure; and
(3) making decisions such as leasing, bond refunding, and working capital management.
The cost of capital is computed as a weighted average of the various capital components, which are
items on the right-hand side of the balance sheet such as debt, preferred stock, common stock, and
retained earnings.
Cost of capital is defined as the rate of return that is necessary to maintain the market value of the
firm (or price of the firm’s stock). Managers must know the cost of capital, often called the minimum
required rate of return in:
(1) making capital budgeting decisions;
(2) helping to establish the optimal
capital structure; and
(3) making decisions such as leasing, bond refunding, and working capital management.
The cost of capital is computed as a weighted average of the various capital components, which are
items on the right-hand side of the balance sheet such as debt, preferred stock, common stock, and
retained earnings.
