Every profit seeking corporations has its own risk return characteristics. Each group of investors in the corporation-bond holders, preferred stock holders, and common stock holders needs a minimum rate of return commensurate with the risks it accepts by investing in the firm. The minimum rate of return that the corporation must earn to satisfy the overall rate of return required by its investors is called the corporationâ€™s cost of capital.
The cost of capital is a term used in the field of financial investment to refer to the cost of a company's funds (both debt and equity), or, from an investor's point of view "the shareholder's required return on a portfolio of all the company's existing securities". It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company, thus setting a benchmark that a new project must meet.
Definition of Cost of Capital:
The required return necessary to create capital budgeting project, such as building a new factory, worthwhile. Cost of capital includes the cost of debt and the cost of equity.
May 24, 2017