Cost of capital

Last updated: 16.03.2016

Cost of capital is the cost rate of the funds that the company uses as its capital, therefore the rate that mixes costs of various sources of finance. It usually has the form of Weighted Average Cost of Capital (WACC), but all the components mentioned below can be also called with the broader term “cost of capital”.


Cost of capital is used to:

  • evaluate investment projects – cost of capital serves as the minimum return that the investment projects shall achieve and as such it is often used as a hurdle rate
  • evaluate the company performance – WACC is a component used in calculation of EVA
  • design optimal capital structure – it is the structure that keeps the cost of capital to minimum and maximizes the value of the company (37)
  • set up dividend payment policy – if the company is able to undertake investments with rate of return exceeding cost of capital, the equity holders may decide to retain the earnings in the company and not pay it out as a dividend (37)


Components of cost of capital from the viewpoint of various sources of finance:


Components of cost of capital from the risk point of view:

  • risk-free rate – yield on government bonds are often used
  • risk premium – the higher is the risk, the higher is the premium. Risk premium is included for:



Used sources:

37. Significance And Components Of Cost of Capital (online). Citation date: 29.1.2016. Available from www:

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