# Calculating Cost of Capitol

By HatedNation, 18th Oct 2010 | Follow this author
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Posted in WikinutMoneyEconomics

This is a quick review of how to calculate cost of capitol. it will review a few issues and attempt to provide realistic business methods.

## Cost of Capital

Cost of capital, also known as “loan constant” is an important investment tool that calculates the entirety of a company’s assets, to include both the total equity and the debt acquired by the company. In order to calculate cost of capitol we must break down and review three separate elements of the company.

The first element in determining cost of capital will be the company’s commitment on returns, commonly referred to as debt. The second element we must review will be preferred stock. Preferred stock is a specific rate of which a company is required to pay out to stock and shareholders. The third element is common stock, which is available for purchase without direct repayment required immediately.

Using these three elements we must calculate the “cost of debt” then calculate the “cost of equity”. Cost of debt is calculated as such: the Net after-tax interest expenses equal (Interest expense) × (1 tax rate) / (Amount of debt) - (Fees)

Cost of equity is the calculation of the cost of equity including preferred stock and common stock. Preferred stock is considered dividend payments so they are not tax deductable. We can use a simplified formula such as debt cost = Principal × (Interest rate × (1 - Tax rate)) then calculate Preferred stock interest cost = Principal × interest rate.

Once we have both of these calculations we will need to compile the percentage cost from each form of funding, and then calculate the weighted cost of capital, which will be based upon the amount of funding and percentage cost of each of the three elements and their forms of funding

Baheti (2009) posted the simplified formula as

“Cost of Capital =

Where D = Value of Debt

E = Value of Equity

V = Total Value of Firm

Cost of debt = Interest rate required by debtholders.

Cost of Equity = Expected rate of return calculated using the CAPM model”s

## Comments

Retired

3rd Dec 2010 (#)

Excellent

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HatedNation

5th Dec 2010 (#)

Hope it helped ;)

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