Specific Cost

16/12/2023

In the context of the cost of capital, “Specific cost usually refers to the individual component costs associated with each source of capital used by a company. The cost of capital is the average rate of return a company is expected to pay to its investors for using their capital.

Cost of Debt:

The cost associated with obtaining funds through debt.

Calculation:

It is typically the interest rate paid on debt. For example, if a company has issued bonds at a 5% interest rate, the specific cost of debt is 5%.

Cost of Equity:

The return required by equity investors for providing funds.

Calculation:

It can be estimated using various models, such as the Dividend Discount Model (DDM) or the Capital Asset Pricing Model (CAPM). The specific cost of equity reflects the expected return on the company’s stock.

Cost of Preferred Stock:

The cost associated with using preferred stock as a source of capital.

Calculation:

It is the dividend rate on the preferred stock. For instance, if a company has issued preferred stock with a 4% dividend rate, the specific cost of preferred stock is 4%.

Weighted Average Cost of Capital (WACC):

The overall cost of capital, considering the weights of each component.

Calculation:

WACC is calculated as the weighted sum of the individual costs of debt, equity, and preferred stock.

The formula is

WACC = (Wd​ × rd​) + (We​×re​) + (Wp​s × rp​s)

Where, Wd​, We​, and Wps are the weights of debt, equity, and preferred stock, respectively, and rd​,re​, and rps are their respective costs.