Page 6 - PowerPoint Presentation

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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