Cost Of Capital vs Capital Structure: Difference and Comparison

The financial world is vast and covers several aspects, such as trading, insurance, corporate finance, derivatives, and indicators. All of them are necessary to run the country’s economy.

Two of the most critical accounting terms are the cost of capital and the capital structure. The capital cost of a company applies to the cost of raising additional capital money.

In contrast, the capital structure calculates returns required by investors that form part of a system of firm ownership.

Key Takeaways

  1. The cost of capital refers to the total cost of financing a company’s operations, including debt and equity financing.
  2. Capital structure, on the other hand, refers to how a company finances its operations using a mix of debt and equity financing.
  3. The optimal capital structure balances the cost of debt and equity financing to minimize the cost of capital and maximize shareholder value.

Cost Of Capital vs Capital Structure

The cost of capital is the cost of raising funds for a company, including debt and equity. It is the minimum return a company must earn on its investments to satisfy its shareholders and lenders. Capital structure is how a company finances its operations and growth through debt, equity, and other securities.

Cost Of Capital vs Capital Structure
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The Cost of capital helps shape the organization’s business structure, evaluating potential investments and measuring financial results. A firm’s income is smaller, its investor risk is more serious, and the financial system is imbalanced if the cost of capital is high.

The capital cost components apply to each funding source, including debt cost, equity costs, cost of retained profits, and share capital costs.

The Capital Structure applies to the amount of debt and equity used by a company in financing its activities and properties. The financial structure of a company is expressed as a debt-to-equity ratio.

Debt and equity funds support the company’s activities, capital spending, procurement, and other investments. Companies tend to decide whether to use loans or equities to fund operations, and management will balance both to find the optimum capital structure.

Comparison Table

Parameters Of ComparisonCost of CapitalCapital Structure
DefinitionInvestments in a single business are subject to the planned capital structure.Debt payments, venture capital, retained benefit, and preferred share capital costs.
Utility Alternative investment evaluation, financial results evaluation.Weighted components of cost of capital
ComponentsDebt payments, venture capital costs, retained benefit costs, and preferred share capital costs.Funding, including debt cost, equity costs, cost of retained profits, and share capital costs.
TerminologyThere is no such terminology for the Cost of Capital.The Capital Structure is also known as WACC or the overall cost of capital.
ImportanceMaximizing the capital of owners.Showing the financial structure of a corporation is regarded as a proportion of short-term and long-term debt.

What is Cost of Capital?

The cost of maintaining funds received from different sources and used in industry is referred to as the capital cost of a company. The cost of capital is the capital framework the business would receive to provide long-range financing for customers.

Money arranges that a company would receive to draw funding suppliers to make the financing available. Maximizing shareholders’ equity is accomplished with the benefit of the cost of capital.

The Cost of capital helps shape the organization’s business structure, evaluating potential investments and measuring financial results. A firm’s income is smaller, its investor risk is more serious, and the economic structure is imbalanced if the cost of capital is high.

The capital cost components apply to each funding source, including debt cost, equity costs, cost of retained profits, and share capital costs. For computing capital costs, there are various formulae.

cost of capital

What is Capital Structure?

The capital structure is the mix of a company’s debt and equity to fund its operations and expansion. Besides, Equity capital is extracted from a company’s shareholdings and claims its potential cash flows and earnings.

Debt is bond issues or bonds, while equity can be capital, common stock, or retained profits. In the financial system, short-term debt is considered too.

The balance sheet contains both debt and equity. The securities of corporations are accumulated with this debt and equity and are also listed on the balances. The Capital Structure may combine a company’s long-lasting, short-lasting debt and common stock.

An overview of the financial structure of a corporation is regarded as a proportion of short-term and long-term debt.

capital structure

Main Differences Between Cost of Capital and Capital Structure

  1. The capital cost is the estimated investment capital structure, while the minimum return on investment is the desired capital structure.
  2. The cost of capital is included in formulating the capital structure, expenditure option assessments, and financial success assessments. Capital structures, on the other hand, minimize investment risk and guarantees.
  3. The capital cost elements are interest costs, equity costs, retained income costs, and share the capital cost of choice. In contrast, the WACC components are weighted capital cost components.
  4. The Capital Structure is referred to as the required capital structure or WACC. Cost of capital, on the other hand, has no replacement word.
  5. The cost of capital allows owners to optimize equity, whereas the capital structure helps to ensure stability.
References
  1. https://www.jstor.org/stable/1809766
  2. https://onlinelibrary.wiley.com/doi/abs/10.1111/j.1745-6622.1999.tb00027.x

Last Updated : 11 June, 2023

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