Cost of Capital Basics
• The cost to a firm for capital funding = the return to the providers of those funds – The return earned on assets depends on the
risk of those assets
– A firm’s cost of capital indicates how the market views the risk of the firm’s assets
– A firm must earn at least the required return to compensate investors for the financing they have provided
– The required return is the same as the appropriate discount rate
Cost of capital, required return, and appropriate discount rate are different phrases that all refer to the
opportunity cost of using capital in one way as opposed to alternative financial market investments of the
same systematic risk.
• Required return is from an investor’s point of view.
• Cost of capital is the same return from the firm’s point of view.
• Appropriate discount rate is the same return used in a PV calculation.