Question

Explain the meaning of capital structure, cost of capital, and weighted average cost of capital.

Answer 1

Answer: Capital Structure : It is defined as the Distribution of debt and equity in the Company Finances. In simple terms distribution of Source of funds ( Debt or Equity) for the Company to run its operations

Cost of capital : It is the minimum return required to decide whether to go for an investment or not. kind of opportunity cost of making an investment. return that an investor could have earned by investing somewhere else with same risk.

Weighted Average Cost of Capital: calculating cost of capital through Proportionally weighted categories of sources of funds whether debt, equity or preferred stock. It tells on an average what rate of return a Company should earn and give back to its source of funds.

Calculated by using formula

WACC = weight of debt * rate of debt*(1-Tax rate) + Weight of equity * rate of equity