Cost of Capital Formulas
1. Cost of Debt (after tax)
For non-redeemable debt:
kd = (I / B0) * (1 - t)
For redeemable debt:
kd = [I * (1 - t) + (RV - B0) / N] / [(RV + B0) / 2]
Where:
I = Annual interest
t = Tax rate
B0 = Net proceeds (amount received)
RV = Redemption value
N = Years to maturity
2. Cost of Preference Share Capital
Irredeemable:
kp = PD / P0
Redeemable:
kp = [PD + (RV - P0) / N] / [(RV + P0) / 2]
Where:
PD = Annual dividend
P0 = Net proceeds from preference shares
RV = Redemption value
N = Years to maturity
3. Cost of Equity Capital
- Dividend Discount Model (constant growth):
ke = (D1 / P0) + g
- Zero growth:
ke = D / P0
- With Dividend Distribution Tax:
ke = [D1 * (1 + t)] / P0 + g
- No dividends (Zero dividend model):
ke = (Pn / P0)^(1/n) - 1
- Capital Asset Pricing Model (CAPM):
ke = Rf + beta * (Rm - Rf)
Where:
D1 = Dividend expected next year
P0 = Current market price of equity share
g = Growth rate of dividends
t = Dividend distribution tax rate
Pn = Price after n years
Rf = Risk-free rate
beta = Beta coefficient (systematic risk)
Rm = Expected market return
4. Cost of Retained Earnings
kr = ke
5. Cost of New Equity (with flotation costs)
kn = (D1 / NP) + g
Where:
NP = Net proceeds from new shares after flotation costs
6. Weighted Average Cost of Capital (WACC)
WACC = we * ke + wd * kd * (1 - t) + wp * kp + wr * kr
Where:
we, wd, wp, wr = weights of equity, debt, preference shares, retained earnings respectively
ke, kd, kp, kr = costs of each capital source
t = corporate tax rate
7. Weighted Marginal Cost of Capital (WMCC)
WMCC =
Cost1, if New Financing <= Break Point1
Cost2, if Break Point1 < New Financing <= Break Point2
Cost3, if Break Point2 < New Financing <= Break Point3
... and so on.
8. Tax adjustment on cost of debt
kd = kd_before_tax * (1 - t)
