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The Cost of Capital - Essay Example

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The cost of capital Customer Inserts His/Her Name Customer Inserts Grade Course Customer Inserts 14 March 2012 Businesses can generate cash inflows from loans. The research focuses on the reasons for paying the cost of capital. The research includes different cost of capital sources…

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The Cost of Capital

Richard Brealey (2001) mentions cost of capital represents the interest paid for the borrowed funds. Cost of capital can also include focusing on Capital Asset Pricing Model (Sheridian, Martin & Keown, 2010). The formula determines the appropriate expected return of alternative projects. The cost of capital is the amount that the investor has to pay in order to generate a series of future dividend incomes, return of investments (Sheridian, Martin & Keown, 2010). For example, Geoff Black (2010) reiterated the business earns $1,000,000 in one year. The profits will grow by 2 percent per year, and the company generates a net worth of $16,666,667 after two years. The cost of capital is arrived at as follows: $1,000,000 /(X- 2%) = $16,666,667. X represents the cost of capital. After computing the formula, X is equal to 8 percent cost of capital figure. Further, the cost of capital can include the return that the stock market investors are expected to earn from their investments in a company. The firm that generates revenues more than the amount of cost of capital will entice the company’s current and prospective investors to invest additional funds into the invested company’s coffers. For example, Microsoft generated a 53 percent return on its equity. The company’s equity is $7.2 billion. Computing, the company’s return on equity is $3.8 Billion. ...
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