Cost of Capital

Abstract

When appraising investments we need to know the investor’s required rate of return (see Chapter 3). This is the discounting rate applied to cash flows to ascertain their net present value (NPV). If NPV is positive a project is deemed to be acceptable because it will add to the value of the business; if negative, it would normally be rejected. Alternatively a project should not proceed unless its discounted cashftow (DCF) yield rate is higher than the required rate of return. This ‘cut‐off’ point, below which proposed investments should be rejected, is the minimum acceptable to investors. It is their cost of capital.