Computation of Specific Cost of Capital.In calculating the cost of capital, the following methods can be used: The three components of cost of capital discussed above can be written in an equation as follows: The higher the debt capital, the more is the risk compared to a firm that has relatively low debts. Here, the premium finds its way to the picture depending on the volume of debts the firm owes. Premium for the Financial RiskДЇinancial risk is associated with the capital structure pattern of the firm. But how much premium? itвЂ™s up to the firmвЂ™s project selection decision which alienates with the firmвЂ™s goal and objectives and how badly they want the project to increase their market value. Thus the premium factor plays an important role here as it increases the Cost of Capital. So, if a firm selects a project that has more than normal risk, then it is obvious that the providers of capital would require or demand a higher rate of return than the normal rate. Premium for the Business RiskД«usiness risk is determined by the capital budgeting decisions that a firm takes for its investment proposals. It talks about the expected rate of return when a project involves no financial or business risks. There are three factors to the cost of capital explained below: Zero Risk Return The source of capital employed by the firm is usually in the following form: In other words, it is the rate of return that the suppliers of capital require as compensation for their contribution of capital. Cost of Capital is the rate of return the firm expects to earn from its investment in order to increase the value of the firm in the market place.

Capital equation accounting