Question

What is cost of capital and why it is important?

Answer 1

Cost of capital is the required return commanded by the capital holders for a capital budgeting project. This is from both the debt and equity holders point of view. It is usually the Weighted average cost of capital or WACC. WACC signifies the risk of a project and thus is used as the discount rate while valuing a project or a firm. This WACC determines the value of the project. Higher the WACC, lower the value and lower the WACC, higher the value. Hence it is very important for a firm to reduce the WACC as much as possible to increase the value.