Optimal cost of capital

Business & Finance
Tutor: None Selected Time limit: 1 Day

How do you calculate your organization's optimal cost of capital? How does an increase in balance sheet debt affect it?

Apr 19th, 2015

General steps involved in determining the optimal capital structure often starts with the calculation of the Weighted Average Cost of Capital (WACC). Usually a company uses a mix of both debt and equity in its capital structure. WACC takes into consideration the overall cost of capital of the company while evaluating how best to suffice the additional funding requirement.

WACC is calculated as follows:

WACC = [{cost of debt * (1-t) * D/V} + {cost of equity * E/V}]

Where D = Value of Debt

E = Value of Equity

V = Total Value of Firm

Cost of debt = Interest rate required by debt-holders.

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

an increase in balance sheet  debt increases the cost of capital  because debt is seen as a way of injecting equity


Apr 19th, 2015

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Apr 19th, 2015
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