cost of capital
Noun: - The opportunity cost of the funds employed as the result of an investment decision. It represents the rate of return that a business must earn on its investments to maintain its market value and attract funds. Essentially, it is the cost of using capital for a specific project, which is the return foregone by not investing that capital in an alternative project with equivalent risk.
The term "cost of capital" is used primarily in finance, corporate finance, and investment analysis. It is a fundamental concept for evaluating the viability of projects, valuing companies, and making strategic financial decisions. It is typically expressed as a percentage rate.
- Noun:
- A company will only proceed with a new project if the expected return exceeds its cost of capital.
- Calculating the weighted average cost of capital (WACC) is a standard practice for large corporations.
- High interest rates can increase a firm's cost of capital, making new investments less attractive.
"Hurdle rate": A synonym often used in corporate finance. A project must clear this minimum rate of return, which is based on the company's cost of capital.
- The management set a hurdle rate of 12%, which is the firm's estimated cost of capital.
In valuation models: The cost of capital is used as the discount rate in discounted cash flow (DCF) analysis to determine the present value of future cash flows.
- The analyst used a cost of capital of 8% to discount the startup's projected earnings.
Weighted Average Cost of Capital (WACC) (n): The average rate of return a company is expected to pay to all its security holders (debt and equity). It is the most common measure of a firm's overall cost of capital.
- The WACC incorporates the cost of both debt and equity financing.
Marginal Cost of Capital (MCC) (n): The cost of obtaining one more dollar of new capital. This cost may increase as a company raises more capital.
- The marginal cost of capital often rises after a certain amount of funding has been secured.
- Required rate of return: The minimum annual percentage earned by an investment that will induce individuals or companies to put money into it.
- Discount rate: The rate used to discount future cash flows to their present value. (In the context of corporate finance, this is often synonymous with the cost of capital).
- Hurdle rate: The minimum rate of return on a project or investment required by a manager or investor.
"To exceed the cost of capital": To earn a return greater than the required minimum.
- For a project to create value, it must exceed the cost of capital.
"To be driven by the cost of capital": To be heavily influenced by financing costs.
- Investment decisions in the utility sector are often driven by the cost of capital.
- Opportunity Cost: The loss of potential gain from other alternatives when one alternative is chosen. The cost of capital is a specific application of this broader economic principle.
- Capital Structure: The mix of debt and equity that a company uses to finance its operations, which directly impacts its cost of capital.
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the opportunity cost of the funds employed as the result of an investment decision; the rate of return that a business could earn if it chose another investment with equivalent risk
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