Cost of Capital

Weighted Average Cost of Capital (WACC)

D E
KC KB * (1 t ) * KS *
V V

KC Cost of Capital (WACC)

KB Cost of Debt
KS Cost of Equity
D Value of Debt
E Value of Equity
V Value of Firm
t Tax rate
Cost of Capital
Cost of Debt

D E
KC KB * (1 t ) * KS *
V V

Bank loans
Bonds
Commercial Paper

Cost of Capital
Cost of Equity

D E
KC KB * (1 t ) * KS *
V V

Shareholders expected return

Cost of Capital
Cost of Equity

K S R f ( Rm R f )

Rf Risk-free rate of return

Rm Market rate of return
Rm - Rf market risk premium
Variance of a companys share against market performance

quantifies the economic and financial risk of a company

If equal to 0, no risk
If equal to 1, risk similar to market
Lets practice

Calculate the cost of capital considering the following information

Debt interest rate 10%

Risk-free rate 5%
Market rate of return 15%
1,2
Value of Equity 200M
Value of Debt 800M
Tax rate 30%