Difference between Cost of Capital and Cost of Equity

Cost of Capital and Cost of Equity have great significance in financial management. Although, these terms are often used together erroneously, but there is a considerable difference between the two. Cost of Capital includes all the cost of all the funds which the company takes on from its creditors as well as shareholders to run and expand its business. In contrast, Cost of Equity only refers to the cost of funds which the company has gathered from its shareholders. Furthermore, Cost of Capital is easy to calculate as compared to the Cost of Equity.

Instructions

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    Cost of Capital

    It is a term which is used in financial management. It refers to the cost of funds which the company takes on in order to run its operation or to make expansion in the business. It includes all the debt which the company takes from its creditors and the equity which is the amount invested by the shareholders (the owners of the company).

    The companies calculate the cost of capital while starting a new project for the expansion of the business so as to evaluate its positive and negative points. If the cost of capital is lesser than the return on the investment, then the project is deemed as feasible. On the other hand, if the cost of capital is greater than the expected return on the investment, then the project is not deemed as feasible. The more the return on capital, the better the investment proposal is. So, it is one of the most important calculations in financial management of the company.

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    Cost of Equity

    It is also an important term used in financial management to calculate the return on shareholders’ investment in the company. Shareholders are the owners of the company and they get their return in form of dividend after the payment of interest is made to the creditors. Moreover, if the company has issued any kind of preferred stocks, the common stock holders will get their return after the preferred stock holders.

    If the company is planning to expand its business operation e.g. opening a new factory, it will have to raise some money from its shareholders for which they will have to calculate the cost of equity in order to find out the feasibility of the project. If the return on equity is more than the cost of equity, it means the project is feasible and vice versa.

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