Cost of capital

The cost of capital is the minimum rate of return required by all providers of funds — shareholders and lenders — to compensate for the risk they bear. When integrating both equity and debt costs weighted by their respective shares in the capital structure, it takes the form of the WACC. The cost of capital is the discount rate benchmark for assessing economic value creation: a return on capital employed (ROCE) exceeding the cost of capital generates value; a ROCE below destroys it. This framework underpins EVA-based valuation models and capital allocation decisions.

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Example: a Swiss company presents a WACC of 9.5% and a ROCE of 12.3%. The positive spread of 2.8%, applied to an economic asset base of CHF 15.0 million, generates annual economic value added (EVA) of CHF 420,000 — a positive signal used in residual income valuation models to quantify value creation beyond the capital invested.

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Hectelion uses the cost of capital as a benchmark for measuring value creation and constructing residual income valuation models.