The remuneration that investors obtain for their contribution of funds is known as the cost of capital.
The cost of capital is the required return on the different types of financing. This cost can be explicit or implicit and be expressed as the opportunity cost for an equivalent investment alternative.
In the same way, we can establish that the cost of capital is the return that a company must obtain on the investments it has made with the clear objective of maintaining, unalterably, its value in the financial market .
The concept that concerns us now is also known as the Minimum Acceptable Rate of Return (MARR). Specifically, in order to calculate it, it is important to take into account two fundamental factors such as the value of inflation itself and the risk premium for the corresponding investment.
Cost of capital and risk estimation
It is important, in this framework, to carry out an exhaustive study of the market. This also means that it is necessary, in order to determine said cost of capital, both total and appropriate, to establish the average cost of capital. To achieve this, what must be undertaken is the clear exposition and achievement of both the marginal weightings and the historical weightings.
Determining the cost of capital, therefore, implies the need to estimate the risk of the venture, analyzing the components that will make up the capital (such as the issuance of shares or debt ). There are different ways to calculate the cost of capital, which depend on the variables used by the analyst.
In other words, the cost of capital represents the remuneration that investors will receive for contributing funds to the company , that is, the payment that shareholders and creditors will obtain . In the case of shareholders, they will receive dividends per share, while creditors will benefit from interest on the amount disbursed (for example, they contribute $10,000 and receive $12,000, which represents an interest of $2,000 for their contribution).
The cost of capital can be understood as the return on financing.
Evaluation and fees
The evaluation of the cost of capital informs about the price that the company pays to use the capital . This cost is measured as a rate: there is one rate for the cost of debt and another for the cost of equity capital; Both resources form the cost of capital.
It should be noted that the capital of a company is made up of external stockholders' equity obtained through the issuance of common shares as opposed to retained earnings, internal stockholders' equity from retained earnings, preferred shares , and the cost of debt (before and after taxes).
That is, when determining the aforementioned cost and also analyzing the capital in depth, we must carry out the establishment and study of extremely important issues in the matter such as the tax deductibility of interest, the rate of return that shareholders require on preferred shares, the level of leverage or the minimum return on shares in countries that do not have a stock market .