Cost of Capital Calculator

With our cost of capital calculator, we aim to help you assess the combined impact of a company's cost of equity and cost of debt. To understand more on this topic, please feel free to check out our WACC calculator and after-tax cost of debt calculator.

This article is designed to enhance your comprehension of:

• What cost of capital is;
• Its significance in assessing a company's investment potential; and
• How to calculate the cost of capital.

We'll also include examples to help you understand the process of calculating the cost of capital.

The cost of capital is a handy metric and tool for assessing a company's cost to finance its operations. A company's assets are financed through debt and/or equity.

The cost of capital also represents the required rate of return investors demand for them to invest or lend money to the company. Generally speaking, the cost of capital is lower for companies that are larger in sales, more stable and have higher growth rates.

There are two components in the cost of capital:

• Cost of equity — This is the return shareholders expect on their investment in the company. It reflects the compensation investors require for taking on the risk associated with owning the company's equity. The cost of equity is typically higher than the cost of debt as it is considered to be more risky to invest and hold equity compared to lending out money.

• Cost of debt — This is the effective rate that a company pays on its borrowed funds. It includes interest payments on bonds and loans. The cost of debt is generally lower than the cost of equity as it is less risky, particularly because creditors have a higher seniority when it comes to claiming funds.

To understand the calculation of the cost of capital, let's explore this with a hypothetical scenario:

• Company name: Delta Technologies
• Cost of equity: 8%
• Cost of debt: 5%

1. Compute the cost of equity.

   The first step is to determine the cost of equity. The cost of equity represents the return that investors expect for the risk they undertake by investing in the company's equity. The cost of equity for Delta Technologies is 8%.

   To understand more about this calculation, check our CAPM calculator.

2. Determining the cost of debt.

   The next step is to compute the cost of debt, which is the effective interest rate the company pays on its borrowed funds. For our example, it is 5%.

3. Calculating the cost of capital.

   Now, the last step is to calculate the cost of capital using the cost of capital formula below:

   cost of capital = cost of equity + cost of debt

   For Delta technologies, this is 13%.

Now that we understand what cost of capital is and how to calculate cost of capital, let's dive deeper into understanding its importance.

• Cost of capital can serve as a benchmark for investment decisions. If the returns on an investment are expected to exceed the cost of capital, the project may be considered viable as it promises to generate value for the shareholders.

• Cost of capital can be used to assess the risk and potential return of investing in a company when compared with other investment opportunities in the market.

• Cost of capital is also an important input used to value a company. Generally speaking, the lower the cost of capital, the higher the valuation.