Cost of Capital

Cost of Capital
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The overall cost of capital is used for investment decision to pay for using the wealth of both debt holders and owners. It is the minimum rate of return that an organization earns to create value for the investors. Besides, the overall cost of capital is used to evaluate projects by, for instance, using the WACC as a hurdle rate with assumptions of having a similar risk in deciding on whether to enter into a plan or not. The cost of capital helps in evaluating a plan with provisions of having two valid underlying assumptions.
To compute the rate of funds, we use the chronological value of equity and debt. The value of capital is determined by the multiplication of the value for every capital source with consideration of its relative weight. After that, the products are added together to settle on the WACC. This is because; the company finances its assets with consideration of either equity or debt. The cost of capital has a representation of compensating a market demand in exchange for bearing the risk of ownership and owning the asset. To determine the WACC, one has to evaluate what percentage of the company is financed by debt or by equity.
The cost of retained earnings represent the company’s cumulative input since initiation (Huizinga, Voget & Wagner, 2018). However, the retained earnings can be pulled back to the firm for usage as capital structure and growth. The shareholders own the retained earnings as the effectual owners of the company.

Besides, shareholders forfeit the opportunity cost for investment elsewhere instead of allowing the firm to fabricate capital.
If the corporation has the prospect to earn a rate of return minus than its cost of capital with a profit rate, it should deem fit to invest. This is because, when the financial markets become unsettled, it is evident for an investor to settle for low-risk investments. It is achievable by looking for assets with a balance of high return with minimum risk.

Reference
Huizinga, H., Voget, J., & Wagner, W. (2018). Capital gains taxation and the cost of capital: Evidence from unanticipated cross-border transfers of the tax base. Journal of Financial Economics.