Page 35 - 5.2 i. Manac Finance ITC Summarised Notes

COST OF CAPITAL

Introduction

• The cost of capital is important as it directly affects the investment
decision and the choice of investments.

• The weighted average cost of capital (WACC) is the dominant indicator
of the cost of capital of an entity and is determined based on a
weighted average of other costs.

• An entity’s capital may consist of several forms of capital, including
equity, preference shares and debt.

• The cost of the primary form of capital – equity – can be calculated
using several methods/models, but predominately we use either
Gordon’s Growth model or the Capital Asset Pricing Model (CAPM).

• The beta coefficient incorporated in the CAPM takes account of the

relevant business entity’s capital structure, and is known as the equity
beta (or geared/levered beta).
• A related concept is the asset beta. The asset beta does not take account of a
capital structure and is also known as the ungeared/unlevered beta.

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