The cost of capital is also called hurdle rate or cut off rate. It is the minimum rate of return expected by the investors. The investor’s decision to invest in a particular firm depends upon the cost of capital or cut off rate of that firm which is the minimum rate of return expected by the investors. The firm may use the capital in the form of equity shares, debentures, preference shares and retained earning. In case the firm is unable to achieve the hurdle rate then the market value of the shares will fall. So it is very essential for the firm to achieve minimum rate of return to get wealth maximization.
To conclude cost of capital (KO) is:
- is not a cost rater it is the rate of return from a particular project.
- Minimum rate of return
- Has 3 components – business risk, financial risk, normal rate of return at zero risk level. KO= B+F+RO
This is the meaning of cost of capital.