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Determining Cost of Capital & difficult part to get correct

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Please explain the various ways of determining the cost of capital and determining which is the most difficult to get right.

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Your tutorial is 457 words and three references and explains which part of the cost of capital is most difficult and why.

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Cost of capital is determined by the weighted average cost of capital formula. That is, the after-tax cost of obtaining capital by either debt, contributions from owners and generating capital through profitable operations (retained earnings). It is typically shown using an algebra equation (shown below) that is a bit intimidating but basically says:

WACC =[ percent debt x after tax cost of debt] +[ percent preferred stock x cost of preferred stock] + [percent common/retained earnings x cost of common/retained earnings]

WACC = wdkd(1-T) + wpkp + wcks

 The w's refer to the firm's capital structure weights.
 The k's refer to the cost of each ...

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Carol Sargent, PhD
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  • MSc, University of Virginia
  • PhD, Georgia State University
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