Factors Affecting the Cost of Capital

Controllable Factors

Capital-structure policy
· As more debt is issued, the cost of debt increases, and as more equity is issued, the cost of equity increases.

Dividend policy
· As the payout ratio of the company increases, the breakpoint between lower-cost internally generated equity and newly issued equity is lowered

Investment policy
· If a company changes its investment policy relative to its risk, both the cost of debt and cost of equity change.

Uncontrollable Factors
· Level of Interest Rates

• When interest rates increase, the cost of debt increases, which increases the cost of capital.

Tax Rates
· Tax rates affect the after-tax cost of debt. As tax rates increase, the cost of debt decreases, decreasing the cost of capital.