Definition of cost of capital

The cost incurred in owning or borrowing capital, including interest payments and dividend obligations. [1]

In order to provide an incentive for those willing to provide capital, the risk-adjusted return on the capital used to fund any given business needs to be higher than the cost of the capital.

A company’s assets are financed by either debt or equity. Risk-adjusted return on capital is the average of the costs of these sources of financing, each of which is weighted by its respective use in the given situation. By taking a weighted average, it is possible to determine how much interest the company has to pay for each monetary unit it finances. [2]