Cost of capital Definition
Companies finance their operations by three mechanisms: Issuing stock (equity), issuing debt (borrowing from a bank is equivalent for this purpose), and reinvesting prior earnings. The cost of capital for a firm is a weighted sum of the cost of equity and the cost of debt. Re-vinvested money is also charged at the cost of equity, since if the money is not reinvested is will normally be returned to shareholders. Investors expect retained earnings to earn the same return as money initially invested. The cost of debt is the cost of borrowing money.