Capital Structure Considerations

The Marginal Cost of Capital

The marginal cost of capital is calculated as the cost of the last dollar of capital raised. Generally, as capital is raised, the marginal cost of capital rises. This happens because the marginal cost of capital is generally the weighted average of the cost of raising the last dollar of capital.

When raising extra capital, firms usually try to stick to the desired capital structure. Once sources are depleted, they will usually have to issue more equity. Since the cost of issuing extra equity seems to be higher than other financing costs, we see an increase in the marginal cost of capital as the amounts of capital raised grow higher.

Cost of Money The Marginal Cost of Capital is the cost of the last dollar of capital raised. The firm should consider this when making corporate decisions.

The marginal cost of capital can also be discussed as the minimum acceptable rate of return or hurdle rate. Capital investment is logically only a good decision if the return on the capital is greater than its cost. Also, a negative return is generally undesirable. As a result, the marginal cost of capital often becomes a benchmark number in the decision-making process to raise more capital. If it is determined that the dollars invested in raising this extra capital could be allocated toward a greater or safer return if used differently, according to the firm, they will be directed elsewhere. For this, we must look into marginal returns of capital, which can be described as the gains or returns made by raising that last dollar of capital.