Cost of capital

Capital has a cost even when no contractual interest payment is made. Equity investors forgo alternative investments and require compensation for risk, while lenders require returns reflecting their contractual claims and credit exposure. For the business, these required returns form the benchmark against which investment value is assessed. The relevant cost depends on the cash flows being valued, their risk, currency and financing assumptions. It is a forward-looking opportunity cost rather than simply the historical interest rate paid on existing borrowing. A company's overall cost combines its different financing sources consistently.