Cost of capital

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The weighted average cost of capital is used by corporations to determine a discount rate for projects that will maintain their stock price and debt coverage.

In simple terms it is the company's expected return on equity averaged with its cost of debt weighted by total debt and total equity. The cost of debt is adjusted by the company's tax rate as debt interest is tax-deductible whereas dividends are not.

The calculation becomes complex when considering hybrid instruments such as preferred shares, synthetic leases, etc.

If a company undertakes a project that returns the weighted average cost of capital, its stock price and cost of debt should remain the same.

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