Understanding the Cost of Capital

In your recently published article on moat stocks, it was mentioned that ROCE is almost always higher than the cost of capital for these stocks. As someone new to the financial markets, I have yet to firmly grasp this concept. Could you please elaborate what this cost of capital is and what is it used for?

- Raunak Chopra

Editor Responds:

Thank you for writing to us with your query. The cost of capital or weighted average cost of capital (WACC) is the cost of a company’s funds, both debt and equity. It is often used to evaluate investment opportunities and in many ways is considered the ‘hurdle rate’ a company has to earn. If a company can achieve returns higher than the WACC, it is a positive sign. Hence, the WACC is often compared to returns such as ROIC and ROCE to determine whether a company is creating value. Hope this clears your doubts regarding this concept. Please do keep writing to us with your feedback!