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Definition

In operational terms, cost of capital refers to the discount rate that is used in determining the present value of the estimated future cash proceeds and eventually deciding whether the project is worth undertaking or not. In this defined as the minimum rate of return that a firm earn on its investment for the firm to remain unchanged.

The cost of capital is visualized as being composed of several elements. These elements are the component of capital. The term component means the different sources from which funds are raised by a firm. Obviously, the source of funds or each component of capital has its for example, equity capital has also preference share capital and so on. The cost of the source or component is called specific cost of capital. When these specific are combined to arrive at overall cost of capital, it b referred to as the weighted cost of capital. The terms, cost of capital cost of capital compose cost of combined cost of capital are used interchangeably in this book. In other words, the term, cost of capital, as the acceptance criterion for investment proposals, is used in the sense of the combined cost of all sources of financing. This is mainly because our focus is on the valuation of the firm as a whole.

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