Journal of Business & Economic Policy

Dissecting the Cost of Capital
M. J. Alhabeeb

Abstract
In order to be capable of confronting the increasingly complicated conditions and tangled circumstances, especially in the aftermath of the economic turmoil of the latest financial crisis, and the growing trends of downsizing and outsourcing, it became critical for the firm’s management to assess the cost of its potential investment projects among many alternatives. This is where the firm’s cost of capital comes to play in the firm’s investment dynamics, as well as in other capital avenues such as mergers or acquisitions, or even in valuing individual securities. Appreciating the crucial role of cost of capital, and having the knowledge and tools to correctly estimate it became one of the most tenacious managerial tasks that a firm can undertake. Here, we go back to the classic theoretical reasoning of the topic in order to provide the necessary clarity to treat the cost of capital factor as compared to the active role of the generic interest or discount rates traditionally used in the calculations of cash flow under the doctrine of the time value of money.

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