Cost of capital

Definition

Cost of capital refers to the total cost a company incurs in order to raise funds for its operations and investments. It represents the overall expense of utilising various sources of financing, such as equity (stocks) and debt (loans or bonds), to support the company’s activities.

What is cost of capital?

The cost of capital takes into account both the cost of equity and the cost of debt. The cost of equity is the return that shareholders expect for investing in the company’s stock, taking into consideration factors like dividends and potential capital gains. The cost of debt, on the other hand, is the interest expense a company pays on its borrowed funds.

Calculating the cost of capital helps a company make informed decisions about which projects or investments to undertake. It serves as a benchmark to assess whether the potential returns from an investment are greater than the cost of obtaining the necessary funds. This analysis is crucial for maintaining profitability and shareholder value.

For businesses, understanding the cost of capital is essential for strategic planning, capital budgeting, and evaluating the financial viability of various opportunities. It’s a fundamental concept in corporate finance that plays a pivotal role in shaping a company’s financial decisions.

Example of cost of capital

XYZ Company is considering a new project that requires an investment of R1 million. The company can finance the project using a mix of equity and debt. The cost of equity is estimated to be 10%, and the cost of debt is 5%.

If XYZ Company decides to use 50% debt and 50% equity to finance the project, the weighted average cost of capital (WACC) can be calculated as follows:

Cost of capital = Cost of equity × Equity weight + Cost of debt × Debt 

In this case:

  • Cost of equity = 10%
  • Equity weight = 50%
  • Cost of debt = 5%
  • Debt weight = 50%

Cost of capital = (0.10 Ă— 0.50) + (0.05 Ă— 0.50) = 0.075

Therefore, the average cost of capital for XYZ Company, in this example, is 7.5%. This represents the overall cost of financing the project taking into account both equity and debt.

Ready to grow your business?

Clever finance tips and the latest news

Delivered to your inbox monthly

Join the 95,000+ businesses just like yours getting the Swoop newsletter.

Free. No spam. Opt out whenever you like.

Our offices:

Disclaimer: Swoop Finance helps South African firms access business finance, working directly with businesses and their trusted advisors. We are a credit broker and do not provide loans or other finance products ourselves. We can introduce you to a panel of lenders, equity funds and grant agencies. Whichever lender you choose we may receive commission from them (either a fixed fee of fixed % of the amount you receive) and different lenders pay different rates. For certain lenders, we do have influence over the interest rate, and this can impact the amount you pay under the agreement. All finance and quotes are subject to status and income. Applicants must be aged 18 and over and terms and conditions apply. Guarantees and Indemnities may be required. Swoop Finance can introduce applicants to a number of providers based on the applicants’ circumstances and creditworthiness. Swoop Finance (Pty) Ltd is registered with CIPC in South Africa (company number 2023/820661/07, registered address 21 Dreyer Street, Cape Town, South Africa, 7708).

© Swoop 2025

Looks like you're in . Go to our site to find relevant products for your country. Go to Swoop