DEFINITION
Cost of Capital

"Cost of capital": Broadly, the rate of return on a firm’s investments which is required to service the providers of the firm’s capital. Often the term is used in a more specific sense to refer to the weighted average cost of capital of a business. For example, say a firm's cost of capital is 8%. The firm must earn a return of at least 8% on its operational investments, in order to provide the investors with the minimum investment return of 8% which they require. The concept of cost of capital is important because when inferior rates of return are earned from operational investments - for example only 5% compared with a cost of capital of 8% - such operations are destructive of shareholder value and need to be improved or discontinued. The results of these operations may appear to be profitable, when considered in simplistic historical cost financial accounting terms.
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