Capital Costs

(noun)

Capital costs are fixed, one-time expenses incurred on the purchase of land, buildings, construction, and equipment used in the production of goods or in the rendering of services. Put simply, it is the total cost needed to bring a project to a commercially operable status.

Examples of Capital Costs in the following topics:

  • Cost of capital

    • The cost of capital is the rate companies must pay to finance a project.
    • The cost of capital refers to the cost of the money used to pay for the capital.
    • In order to determine a company's cost of capital, the cost of debt and the cost of equity must be calculated.
    • One way of combining the cost of debt and equity to generate a single cost of capital number is through the weighted-average cost of capital (WACC).
    • The cost of capital is the cost of the money used to finance the plant.

  • The Marginal Cost of Capital

    • The marginal cost of capital is the cost needed to raise the last dollar of capital, and usually this amount increases with total capital.
    • The marginal cost of capital is calculated as being the cost of the last dollar of capital raised.
    • Generally we see that as more capital is raised, the marginal cost of capital rises .
    • The Marginal Cost of Capital is the cost of the last dollar of capital raised.
    • Describe how the cost of capital influences a company's capital budget

  • Cost of Capital Considerations

    • Cost of capital is important in deciding how a company will structure its capital so to receive the highest possible return on investment.
    • One of the major considerations that overseers of firms must take into account when planning out capital structure is the cost of capital.
    • For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital.
    • The weighted average cost of capital multiplies the cost of each security by the percentage of total capital taken up by the particular security, and then adds up the results from each security involved in the total capital of the company.
    • Describe the influence of a company's cost of capital on its capital structure and investment decisions

  • Defining the Cost of Capital

    • The cost of capital is the cost of obtaining funds, through debt or equity, in order to finance an investment.
    • Thus, the cost of capital is a benchmark that a new project has to meet.
    • For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital.
    • A more specific calculation of cost of capital is the weighted average cost of capital.
    • The cost of capital serves as a benchmark in financial decision-making.

  • Weighted Average Cost of Capital

    • The WACC is the cost of capital taking into account the weights of each component of a company's capital structure.
    • The weighted average cost of capital (WACC) is the rate a company is expected to pay, on average, to its security holders.
    • Stated differently, the return on capital of a new project must be greater than the weighted average cost of capital.
    • Since companies raise money using any number and combination of these sources - i.e. debt, common stock, preferred stock, retained earnings - it is important to calculate the cost of capital taking into account the relative weights of each component of a company's capital structure.
    • In order to calculate WACC, a few inputs must be known, namely, the cost of debt, the cost of equity, and the company's marginal tax rate.

  • Optimal Capital Structure Considerations

    • Actual market considerations when dealing with capital structure include bankruptcy costs, agency costs, taxes, and information asymmetry.
    • For an investment to be worthwhile, the expected return on capital must be greater than the cost of capital.
    • A company's securities typically include both debt and equity; therefore, one must calculate both the cost of debt and the cost of equity to determine a company's cost of capital.
    • The weighted average cost of capital multiplies the cost of each security by the percentage of total capital taken up by the particular security, and then adds up the results from each security involved in the total capital of the company.
    • Explain the influence of a company's cost of capital on its capital structure and therefore its value

  • Impact of the SML on the Cost of Capital

    • The plotted location of an instrument on the SML has consequences on its price, return, and cost of capital it contributes to a firm.
    • The cost of obtaining funds in such a manner is known as a company's cost of capital.
    • The rational investor will require either a higher return or lower price, which will both result in a higher cost of capital for the company.
    • The location of a financial instrument above, below, or on the security market line will lead to consequences for a company's cost of capital.
    • Describe the impact of the SML on determining the cost of capital

  • Cost of Improvements

    • The cost of an asset improvement is capitalized and added to the asset's historical cost on the balance sheet.
    • The cost of the improvement is capitalized and added to the asset's historical cost on the balance sheet.
    • If the capital improvement is financed, the interest cost associated with the improvement should not be capitalized as an addition to the asset's historical cost.
    • Interest costs are not capitalized for assets that are not under construction.
    • When the cost of a capital improvement is capitalized, the asset's historical cost increases and periodic depreciation expense will increase.

  • Types of Costs

    • It consists of variable costs and fixed costs.
    • Total cost is the total opportunity cost of each factor of production as part of its fixed or variable costs .
    • Variable costs are also the sum of marginal costs over all of the units produced (referred to as normal costs).
    • They include inputs (capital) that cannot be adjusted in the short term, such as buildings and machinery.
    • Economic cost is the sum of all the variable and fixed costs (also called accounting cost) plus opportunity costs.

  • Economic Costs

    • An example of economic cost would be the cost of attending college.
    • So, the economic cost of college is the accounting cost plus the opportunity cost.
    • So, the economic cost of college is the accounting cost plus the opportunity cost.
    • Total cost (TC): total cost equals total fixed cost plus total variable costs (TC = TFC + TVC) .
    • Inputs include labor, capital, materials, power, land, and buildings.