The cost of capital is one of the most important, and least understood, concepts in corporate finance. While it can be regarded as a fundamental building block of corporate finance, the cost of capital is frequently ignored by many companies as they go about their day-to-day operations. Investments or projects that are capable of earning returns greater than the cost of capital add value for shareholders. Therefore, by ignoring the cost of capital, companies run the risk of misallocating capital and therefore destroying rather than creating shareholder value.

This tutorial will provide you with the tools necessary to determine debt and equity capital costs, so that a proper comparison can be made between a company’s cost of capital and the return actually being earned on that invested capital.

Objectives
On completion you will be able to:

• Describe the risk/return nature of debt capital and the tax benefits to be derived from the use of debt as a financing tool
• Explain the capital asset pricing model (CAPM) and how it is used to determine the appropriate cost of equity capital
• Calculate the weighted average cost of capital (WACC) for a company
• Describe the common pitfalls in the use of cost of capital