Cost of Capital

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Cost of capital is the cost associated with deploying capital into a potentially productive investment. This cost could be the opportunity cost of forgoing another opportunity. Companies can raise capital through both debt and equity, and the cost of capital can vary across these two methods.

The cost of capital for debt financing is simply the amount that the company must pay in interest to maintain the debt. However, this fails to account for the fact that the amount of debt the company can raise at this price may be limited.

The cost of capital for equity is a more complex calculation that depends on the demanded return of investors. This assumes that the company should be able to create value, and any investment has an opportunity cost of forgoing another investment opportunity.