The cost of capital is one of the most important concepts in finance. It is the minimum acceptable return that new investments must generate and represents the long-term opportunity cost of the funds used by a company. If management chooses to invest in projects with expected returns above cost of capital, the value of the company increases. On the contrary, if a company invests in projects (which despite the positive profitability) with expected returns below the cost of capital, it destroys value and the value of the company falls. Also, the cost of capital is the discount rate that should be used in discounted cash flow (DCF) analysis, in capital planning applications, when valuing a business or division, or an acquisition target.
January 01, 2012
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