Cost of Capital
Cost of capital is a hurdle rate calculated based on a company’s cost of equity and cost of debt. The most commonly used approach is the weighted average cost of capital (WACC) which weights the cost of capital based on the amount of debt and equity a company currently holds. The cost of debt is generally calculated based on the average debt service percentage. A company who has a Return on Invested Capital above its WACC is generally viewed as creating Economic Profit for all its investors. If the return on invested capital is below its WACC, that company may have trouble sustaining its operations in the future.
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