What is Cost of Capital?
Cost of capital is the annual return a business must pay lenders and investors, or give up, in exchange for using their money. For a whole company it is a blended rate across debt and equity, usually called the weighted average cost of capital (WACC). For a single funding offer it is the effective annual rate with every fee included.
Cost of capital is often used as the discount rate in a discounted cash flow model, which is why the two terms are frequently treated as the same thing.
Formula
WACC = (E ÷ V × cost of equity) + (D ÷ V × cost of debt × (1 − tax rate))
E = equity, D = debt, V = E + D
Single offer: effective annual rate = (total fees and interest ÷ average balance) × (365 ÷ days held)
Example
Illustrative: a brand takes a $10,000 advance at a factor rate of 1.15, repaid evenly over 180 days.
- Fee: $10,000 × 0.15 = $1,500
- Average balance: about $5,000, because repayment starts immediately
- Effective annual rate: ($1,500 ÷ $5,000) × (365 ÷ 180) = about 61%
The quote said 1.15. The money cost about 61 percent a year.
Why Cost of Capital Matters for Operators
An order, a hire or a campaign creates value only when its return on capital is higher than the cost of the money that funds it. Converting every offer to an effective annual rate is also the only way to compare a line of credit, a flat-fee advance and revenue-based financing on the same basis.
Full guide → Cost of Capital for Ecommerce: What Each Funding Type Really Costs
FAQ
How do you calculate cost of capital?
For a company, weight the cost of equity and the after-tax cost of debt by their share of total capital (WACC). For one funding offer, add up every fee and all interest, divide by the average balance you hold, and multiply by 365 divided by the days you hold it.
What is a good cost of capital?
There is no universal good number. It depends on the funding type, your credit profile, revenue history, existing debt and how long you hold the money. A cost of capital is acceptable when it is below the return the funded activity earns, with room to spare.