Cost of capital

Cost of capital represents the minimum rate of return that a firm must earn on its investment so that the market value of the firm would remain unchanged. A firm generally runs its business using various sources of funds. Each source has its own cost which is termed as specific cost of capital and when these specific costs are integrated by using appropriate weights, it is called weighted average cost of capital. The various computational methodologies of specific costs of different components of capital and weighted cost of capital are discussed in this paper. There are different approaches in measuring cost of equity like Dividend Model, Dividend Growth Model, Earning Model, Earning Growth Model and CAPM are applied to calculate the cost of equity. The value of ‘b’ is the growth rate which is measured with the help of time series analysis i.e. the growth of dividend is measured for the years under consideration. The same representation is made in developing the concept of cost of capital which a student find difficult to remember.