Wednesday, December 30th, 2009

In computing the cost of capital, why do we use the current costs of existing debt and equity?

debt for equity
YeRongTian asked:


In computing the cost of capital, why do we use the current costs of existing debt and equity, instead of the historical costs of existing debt and equity as determined in the market?

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3 Responses to “In computing the cost of capital, why do we use the current costs of existing debt and equity?”

Joseph M Says:
December 30th, 2009 at 6:13 am

the current debt and equity numbers are an accurate account of the credit rating of a company and therefore the required return or the cost of capital. Debt and equity are used directly to compute the Weighted Average cost of Capital or the WACC

dredude52 Says:
January 1st, 2010 at 2:45 am

Probably to allow for the current cost of money, borrowing cost, and carrying cost, all tied to a fluctuating yield or interest rate (current).

We don’t want to know the cost of money last year (historical), but today.

Don’t forget, the cost of capital is a “weighted” sum of the cost of equity and the cost of debt (external), and reinvesting prior earnings.

Do you want to “weight” the past or present?

OPM Says:
January 3rd, 2010 at 8:26 am

Historical costs, while possibly interesting, are sunk costs and are irrelevant today. The future cannot be predicted, so only today matters.

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