Cost of Capital Formulas

Cost of Capital Formulas

Cost of Capital Formulas can be classified into Following Formulas. It is to be noted that all three element collectively make the weighted cost of capital (WACC). The following cost of capital formulas has been explained in details in my other articles with examples.

                     Cost of Equity Formulas

                    Cost of Debt Formula

              Cost of Preference Shares

.   Cost of Equity Formulas

Cost of Equity can be calculated primarily by two methods i.e. CAPM and dividend discount model. Both methods formulas have been given below;

Dividend Valuation Model Formula –No Growth (Constant Dividend)

Cost of equity is calculated by simply dividing the dividend by market price of share.

Cost of Equity =    Do                                    Po

Do= Dividend

Po= Market Share price

Dividend Valuation Model Formula – Constant Growth

Cost of equity for company with constant growth in Dividend may be calculated by following formula,

Cost of Equity =[Do (1+g)] + g                                   Po

g = Dividend growth Rate

Ke = Cost of Equity

Do =Current Dividend

Po= Share price

Capital Asset Pricing Model:

Cost of equity can be calculated by capital asset pricing method .Capital asset pricing model takes into account the relative risk of market.

Cost of Equity= Rf + β (Rm- Rf)

Rf= Risk Free Return

Rm= Market Return

Β =Risk Factor

 2 Cost of Debt

Cost of debt can be calculated by the following formulas.

Cost of irredeemable Debt Formula

Cost of debt which will never be paid back is known as irredeemable debt. Cost of irredeemable debt is calculated by the following formula.

Cost of Irredeemable Debt Formula =    Io (1-t)                                                                            Po

Where,

Io= Interest Rate

T= Tax Rate

Po= Market value of debt (Ex interest Price)

Cost of Redeemable Debt Formula

Cost of Redeemable Debt is calculated by the Internal Rate of return formula.

Cost of Redeemable Debt=RL+ [      NPVL           ] x (RH-RL)                                                        NPVL-NPVH

R_L= Lower rate of Return

R_H= Higher Rate of Return

NPV_L= NPV with Lower rate of Return

NPV_H= NPV at higher rate of return

Cost of Preference Share

Cost of preference share can be calculated by the following formula. This formula is more like Cost of irredeemable debt, but off course with no tax shield.

Kp =     Do                  Po

Do= Dividend on preference shares

Po= Market Price of preference shares