Lesson 1 of 6 · 14 min
The cost of capital and WACC
A company's cost of capital is the return its lenders and shareholders require, blended into one weighted-average rate that becomes the hurdle every new investment must clear.
In short
- The cost of capital is investors' required return; it is set in financial markets, not chosen by management.
- Debt is cheaper than equity: lenders hold a priority, fixed claim (sometimes secured), shareholders a residual one; interest is often tax deductible, dividends are not.
- WACC = after-tax cost of debt × weight of debt + cost of equity × weight of equity (plus any other sources such as preferred stock).
- Use market value weights (investors' opportunity cost) or management's target weights; book values reflect history.
- WACC is the discount rate *r* in NPV and the hurdle rate for IRR, adjusted for project-specific risk.
- Management's two capital structure aims: the lowest WACC and, where economical, matching the horizon of financing to the assets.
Unlock this lesson free for 7 days
Create a free account to get 7 days of full access — every lesson, video, flashcard, mock and the question bank. No card needed.