What is Cost of Capital?
The cost of capital is the weighted average rate of return required by a business’s debt and equity providers, used as the discount rate in NPV and DCF analyses and as the hurdle rate for capital investment decisions.
How It Works
- Formula: WACC = (E/V × Re) + (D/V × Rd × (1 – tax rate)).
- Re = cost of equity (from CAPM: risk-free + beta × equity risk premium).
- Rd = cost of debt (effective interest rate on borrowings).
- Weights based on market values of debt and equity, not book.
Saudi Context
Saudi WACC calculations use the 10-year Saudi government sukuk yield as the risk-free rate (typically 4% to 5%) plus an equity risk premium of 5% to 6%. Saudi listed companies commonly report WACC of 8% to 12%. For zakat payers, the tax-shield adjustment on debt is minimal because zakat is a flat 2.5% of base, not income.
Example
A Saudi company has 60% equity (cost 12%) and 40% debt (cost 6%, no tax shield because it’s a zakat payer). WACC = 0.60 × 12% + 0.40 × 6% = 9.6%.