Cost of Capital and your Investments - What is wise?

What is your cost of money?

I often ask companies if they have a hurdle rate for investments to their facilities. Some of them don't know. Others tell me they want investments to pay off in 2-3 years. Others have told me they want payoffs in one year. It is interesting to hear these demands and try to correlate these responses to the organization's cost of capital, which is likely close to 5-15% than it is 30-60%, however this is the implicit response i get from facility managers. This implies a misunderstanding of the cost of money.

The cost of money can be computed or reached in many ways. There is a cost of equity capital and a cost of debt capital, and the combined cost of capital depends on the capital structure of the organization.

For the consumer, the cost of debt and equity capital could be computed the same way. Debt is money that you borrow, equity is money that is already yours. What is the cost of your debt? What is the yield of your savings?

Another interesting slice on this questions for persons and non public companies is looking at the marginal cost of capital. Debt cost is easy to come up with. It's the rate that we are charged. The marginal rate of equity capital can be looked at by looking at our various uses of our own money. From an individual’s standpoint, he/she could evaluate the varying cost of money from different sources:

• Investment account: What is your average return?
• Bank account: What is the interest that you are receiving?
• Do you have a lot of money to spend, "just for the fun of it?" If so, your cost of equity capital is essentially 0%, since you don't expect any (financial) return from your money.


What are other important considerations?
• Need for liquidity
• Risk of projects
• Other?


In evaluating whether an investment in energy efficiency or renewable energy is wise or not, look at its rate of return vs. your other investments or uses of money. The "green" projects likely still outweigh your cost of capital, whether debt or equity, and likely exceed the return of your other investments.

See how the numbers compare. I'd be interested in your results.