Cost of Capital Terms
Why Cost of Capital matters in interviews
These terms are key components of valuing a business. But why? The Cost of Capital drives investment decisions and thus you need to deeply understand how each term actually affects that decision making process in an interview.
C
- Capital Asset Pricing Model (CAPM) & Cost of Equity (CoE)Cost of CapitalThe CAPM is a north star formula that is used to calculate the Cost of Equity (CoE).
- Cost of Debt (CoD)Cost of CapitalThe Cost of Debt (CoD) is the aggregate interest rate across all loans. You calculate it by putting the total amount of interest over the total amount of debt.
M
- Market ReturnCost of CapitalThe Market Return is commonly used in the CAPM formula to calculate the Cost of Equity (CoE). It is typically quantified as the average return for a major market index like the S&P 500.
- Market Risk Premium (MRP)Cost of CapitalThe Market Risk Premium is the additional return investors expect for taking on the risk of investing in the stock market instead of a risk-free security.