IGNOU BCOE 143 2026 - What is cost of capital? Explain the importance of Weighted

Question

What is cost of capital? Explain the importance of Weighted Average Cost of Capital (10) (WACC) in capital budgeting decisions.

12 Feb 2026

Answer :

Word Count : 593

Cost of capital refers to the minimum rate of return that a company must earn on its investments in order to satisfy its investors, both debt holders and equity shareholders. It represents the opportunity cost of using funds in a particular project instead of investing them in alternative opportunities of similar risk. In simple terms, it is the price paid by a firm for raising capital from various sources such as equity shares, preference shares, debentures, and retained earnings. Each source of finance has its own specific cost, and the overall cost of capital reflects the combined cost of all these sources. The cost of capital is generally classified into cost of debt, cost of preference share capital, cost of equity capital, and cost of retained earnings. The cost of debt is the effective rate of interest paid on borrowed funds, adjusted for tax benefits because interest is tax-deductible. The cost of equity represents the return required by equity shareholders for investing in the company, considering the risk involved. Retained earnings also have a cost, as shareholders expect returns on profits reinvested in the business instead of being distributed as dividends. Weighted Average Cost of Capital (WACC) is the average of the costs of different sources of finance, weighted according to their proportion in the firm’s capital structure. It

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