cost of capital
Cost of capital is the minimum return a company must earn to justify the cost of its financing, from both equity and debt.
Why cost of capital is your real performance baseline
Cost of capital defines the minimum return a business must generate to satisfy its investors and lenders. It sets the threshold between creating value and destroying it. Earn less than this benchmark, and you’re eroding shareholder value. Earn more, and you’re building a business that compounds.
This metric blends the expectations of both equity holders and debt providers. The weighted average—known as WACC—becomes your real-world discount rate in valuation models. It reflects risk, financing structure, and market conditions. But more than that, it forces clarity. If a project doesn’t exceed this cost, it’s not worth doing. Period.
In high-growth environments, many teams chase top-line growth without asking if it beats their capital cost. That’s a mistake. Growth that’s not profitable relative to funding drag is a fast path to dilution or worse. I’ve seen ambitious product bets stall not because the idea was bad, but because the hurdle was higher than they realized.
A practical example of cost of capital: funding tradeoffs and thresholds
Imagine a company raises $5 million: half as equity at a 15% expected return, and half as debt with a 6% interest rate. The result is a blended cost of capital of 10.5%. That’s now your benchmark. Any new initiative, expansion, or investment needs to beat that number.
Say you’re evaluating a new product expected to return 9%. On paper, it’s positive. But in reality, you’re earning less than it costs you to fund the effort. That gap erodes enterprise value. I’ve worked with founders who only realized this after a few cycles of disappointing results. Once they began prioritizing returns over vanity metrics, capital allocation improved—and outcomes followed.
This number isn’t just for the CFO. Product, strategy, and operations teams all make decisions that either beat or fall short of it. Awareness across functions is what separates companies that compound from those that just spend.
What this number is not
It’s not a fixed percentage. It changes with market rates, risk appetite, and your capital mix. Another mistake is ignoring the difference between equity and debt. Equity is more expensive—it carries higher risk and higher return expectations.
It’s also not interchangeable with internal rate of return or ROI. Those measure what you might gain. This defines what it costs you to try. Confuse the two, and you’ll misprice your strategic options.
Make it part of every strategic bet
Cost of capital is not just a finance metric—it’s the baseline for every decision that puts money to work. Ignore it, and you risk confusing activity with value.
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