WACC
Companies finance their project with money they get from preferred stockholders, common shareholders, lenders etc. This is why, when they undertake any operation, they keep in mind to generate at least ‘the least amount of return’ that would satisfy all these investors. The minimum rate, that is calculated for each project, to satisfy the investors is called the required return. Corporations calculate a weighted average of these required return. This is the Weighted Average Cost of Capital or simply called WACC.
Cost Of Capital
Required return, cost of capital and appropriate discount rate are interchangeable terms. They mean the same thing.
Cost of capital is determined by the usage of funds rather than source of fund. This is a little counter-intuitive. But don’t worry! Here’s some further explanation 🙂 –
Investors put there money in assets with different levels of risk. They want higher return when the risk is high and lower return when the risk is low. That is why the required return is not the same for even a single investor when we consider his different assets. I guess this argument applies more to common equity holders that bond issuers or preferred stock holders as the latter ones require more or less fixed rates of return.
So, the riskiness of an investment affects its required rate of return(i.e. cost of capital). That is why cost of capital is determined by the usage of funds and not the sources of funds.
RaihanRiad 