How to calculate the overall cost of capital in capital structure?

To calculate the overall cost of capital in a capital structure, you need to consider the weighted average cost of capital (WACC). WACC is the average rate of return a company expects to pay to all its security holders to finance its assets.

Here is how you can calculate the WACC:

1. Determine the cost of each source of capital: Start by calculating the cost of debt and the cost of equity. The cost of debt can be calculated by dividing the annual interest expense by the total amount of debt. The cost of equity can be calculated using the Capital Asset Pricing Model (CAPM) or the Dividend Discount Model (DDM).

2. Determine the weight of each source of capital: Calculate the proportion of each source of capital in the company's capital structure. This can be done by dividing the amount of each source of capital by the total capital structure.

3. Calculate the weighted average cost of capital (WACC): Multiply the cost of debt by the weight of debt, and the cost of equity by the weight of equity. Then, add these two values together to get the WACC.

The formula for calculating WACC is:

WACC = (Cost of Debt x Weight of Debt) + (Cost of Equity x Weight of Equity)

By calculating the WACC, you can determine the overall cost of capital in the company's capital structure. This can help in making financial decisions and evaluating the company's performance.

Answers