Problem:
What does a company's cost of capital represent and how is it calculated? How do market rates and the company's perceived market risk impact its cost of capital, and how does the company's debt to equity mix impact this cost of capital? You are leading the review of these elements in a meeting with managers and accountants.
Objective:
Must define the cost of capital and explain why marginal capital is important. An understanding of the Capital Asset Pricing Model (CAPM) and the inter-relationship between a company's perceived market risk (as defined by beta) and the market risk-free rate and risk premium is essential. Cost of capital is a firm's borrowing rate (AKA Ke, hurdle rate, discount rate) and marginal is important because it illustrates what our next venture's cost of capital will be.