Cost of capital
Cost of capital is the minimum return your business needs to earn to justify using money, whether it comes from lenders or from owners. It acts as a practical hurdle rate for pricing, investment decisions and valuing the business.
Simple decision lens
If a project’s expected return is higher than your cost of capital, it likely adds value; if it’s lower, it destroys value. This helps compare options with different risks and funding.
It combines the cost of debt (interest and fees on loans, overdrafts or asset finance) and the cost of equity (the return owners expect for taking risk and tying up their money). Many firms use a weighted average to reflect their usual mix of debt and equity, so the benchmark matches how the business is funded.
What usually goes into the cost of capital:
- Cost of debt: the effective rate you pay to borrow, including fees and the risk profile of your business and security.
- Cost of equity: the return owners require compared with other opportunities and the risk of your business.
- Weighted Average Cost of Capital (WACC): a blended rate based on your long‑term target mix of debt and equity, used for whole‑business or steady projects.
- Project risk adjustments: riskier projects warrant a higher hurdle; more certain, secured or short‑term work may justify a lower one.
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