Difference between revisions of "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. | 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. | + | 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. | 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, | + | 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. |
[[category:economics]][[category:finance]][[Category:Business]] | [[category:economics]][[category:finance]][[Category:Business]] | ||
Revision as of 04:52, September 30, 2007
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.