How to Calculate Unlevered Cost of Capital

by Ryan Menezes

Companies raise capital by either raising debt or raising equity. To raise debt, the company borrows money, and to raise equity, it issues new stock. The firm's levered cost of capital takes both sources into account, including debt, which is often the cheapest form of capital acquisition. The unlevered cost of capital assumes that the firm issues no debt at all. It can only issue preferred stock, which offers set dividends, and common stock, whose dividends grow along with the company's income.

Divide the value of preferred dividends by the price of the preferred stock. For example, if the company issues its preferred stock for $25 per share and guarantees dividends of $3.50 annually, divide $3.50 by $25, giving 0.14.

Multiply this value by the proportion of capital that you plan to raise through preferred stock. For example, if you plan to raise 40 percent of your capital through preferred stock, multiply 0.14 by 0.40, giving 0.056.

Divide the value of the common stock's current dividends by its stock price. For example, if the company issues common stock for $30 per share and the stock receives dividends of $4.50 annually, divide $4.50 by $30, giving 0.15.

Add your net income's growth rate. For example, if you anticipate a growth rate of 5.5 percent, add 0.15 to 0.055, giving 0.205.

Multiply this value by the proportion of capital that you plan to raise through common stock. With this example, where you raise 60 percent of your capital from common stock, multiply 0.205 by 0.6, giving 0.123.

Add this ratio to the ratio from Step 2. 0.123 plus 0.056 is 0.179.

Multiply this total ratio by the amount of capital that you plan to raise. For example, if you plan to raise $20,000, multiply $20,000 by 0.179, giving $3,580. This is the levered cost of capital.

About the Author

Ryan Menezes is a professional writer and blogger. He has a Bachelor of Science in journalism from Boston University and has written for the American Civil Liberties Union, the marketing firm InSegment and the project management service Assembla. He is also a member of Mensa and the American Parliamentary Debate Association.

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