in this video you are going to learn cost of capital topics I have covered are what is cost of capital types of cost of capital cost of capital formula components of cost of capital and importance of cost of capital let's start the video the cost of capital is the minimum return that a company or an investor expects to earn on their investment to compensate for the risk involved it represents the cost of funds used to finance a business or a project and is expressed as a percentage before a business can turn a profit it must at least generate sufficient income to cover the cost of the capital it uses to fund its operations this consists of both the cost of debt and the cost of equity used for financing a business the cost of capital is used in capital budgeting to determine whether a project or investment is profitable if the return on investment is less than the cost of capital then the project or investment is not considered economically viable types of cost of capital the cost of capital can be broken down into two main types debt cost of capital and Equity cost of capital let's discuss the debt cost of capital debt cost of capital refers to the cost of borrowing money it includes interest rates and fees associated with loans bonds or other debt instruments the cost of debt capital is the interest rate that the company pays on its outstanding debt let's understand it by an example if a company issues bonds to finance its operations or investment projects the cost of debt capital for the company would be the interest rate that the company pays on its bonds for instance if a company issues one million dollars in bonds with an interest rate of five percent the cost of debt capital for the company would be five percent this means that the company must earn at least a five percent return on its investment to compensate its bondholders for the risk of investing in the company the cost of debt Capital can also vary depending on the creditworthiness of the borrower if the company has a good credit rating it may be able to issue bonds at a lower interest rate conversely if the company has a poor credit rating it may have to pay a higher interest rate to attract investors it is important to note that the cost of debt is tax deductible which can lower the overall cost of capital for the company for example if the company is in a 20 tax bracket and pays fifty thousand dollars in interest on its bonds it can reduce its tax liability by ten thousand dollars number two Equity cost of capital Equity cost of capital refers to the cost of using Equity financing to raise capital it is the return required by investors to compensate for the risk of investing in a company's stock the cost of equity capital is typically higher than the cost of debt Capital because Equity investors have no guaranteed return on their investment an example of equity cost of capital is a company that issues shares of its stock to raise capital the cost of equity capital for the company would be the return that investors expect to earn on their investment in the company's stock for instance if a company issues shares of its stock at fifty dollars per share and investors expect to earn a 10 return on their investment the cost of equity capital for the company would be ten percent this means that the company must earn at least a 10 percent return on its investment to compensate its shareholders for the risk of investing in the company the cost of equity Capital can also vary depending on factors such as the company's financial performance industry Trends and market conditions companies that are perceived as less risky or have a strong financial performance may be able to raise Capital at a lower cost of equity on the other hand companies that are perceived as more risky or have a weak financial performance may have to offer a higher return to attract investors now come to cost of capital formula the cost of capital formula is used to calculate the weighted average cost of capital or wacc which is the average cost of capital for a company the formula is where e is the market value of the company's equity D is the market value of the company's debt V is the total market value of the company's Capital which is market value of companies Equity plus market value of the company's debt e plus d re is the cost of equity road is the cost of debt and TC is the corporate tax rate the wacc or weighted average cost of capital is an important metric for companies to use in capital budgeting and investment decisions if the return on investment is less than the weighted average cost of capital the investment is not considered to be generating enough return to justify the cost of capital components of cost of capital since I discussed cost of equity and cost of debt earlier in this video I am not discussing again other components of the cost of capital include weighted average cost of capital or wacc this is the overall cost of capital for a company and is calculated by taking the weighted average of the cost of debt and cost of equity based on the proportion of debt and equity in a company's capital structure cost of preferred stock this is the cost of issuing preferred stock which is a type of stock that pays a fixed dividend and has priority over common stock in the distribution of dividends and assets marginal cost of capital this is the cost of raising an additional dollar of capital beyond the existing level of capital it reflects the cost of new capital that a company will incur if it increases its investment opportunity cost of capital this is the cost of the next best investment opportunity that a company foregoes in order to pursue its current investment it represents the potential return that could have been earned if the company had chosen to invest in a different opportunity understanding the components of the cost of capital is important for companies in making financial decisions such as capital budgeting investment analysis and cost of financing let's move on to importance of the cost of capital cost of capital is an important Concept in finance for the following reasons number one investment decisions cost of capital is used to evaluate investment opportunities and determine whether they are profitable or not financing decisions the cost of capital helps companies determine the most cost effective way to raise capital by comparing the cost of debt in equity companies can decide whether to issue debt Equity or a combination of both to finance their operations and Investments dividend policy if the cost of capital is high a company may need to retain earnings and reinvest them back into the business to achieve its desired return instead of paying out dividends capital structure by balancing the cost of debt and Equity companies can structure their capital in a way that minimizes their cost of capital and maximizes their overall value performance evaluation by comparing the company's actual return on investment with its cost of capital analysts can assess how well the company is utilizing its resources and whether it is generating sufficient returns to satisfy its investors overall understanding the cost of capital is crucial for making informed financial decisions and maximizing shareholder value if you want to read in details or download the PDF go through the link in the description if you want to suggest me any topic feel free to send it by Instagram or by email like the video and don't forget to subscribe to education leaves