Financial Management: Core Concepts, Third Edition

11.1 The Cost of Capital: A Starting Point

What is the cost of capital? The cost of capital is the cost of each financing component that the firm uses to fund its projects multiplied by that component’s percentage of the total funding amount. So the very first question we want to ask is this: From what sources can a company raise money?

Sources of funds include the following:

1. Commercial banks

2. Nonbank lenders

3. Owners of the company (common stockholders)

4. Preferred stockholders

5. Suppliers

6. The company itself—that is, the cash flow from operations

By looking closely at the list, we can see that these sources are the same individuals and institutions that have claims against the company: the firm’s liability and equity accounts from the right ...