MBA Boot Camp: Cost of Capital & Risk (3.2)
Concepts & Vocabulary
Cost of Capital: The minimum return a company must earn on its investments to satisfy its investors and lenders. It’s what it "costs" the company to get money.
Debt Financing: Borrowing money (loans, bonds). You must pay it back with interest, but you keep full ownership of your company.
Equity Financing: Selling a piece of your company (shares/stock) to investors. You don't have to pay them back, but you give up a percentage of your profits and control forever.
Core Lesson: How Companies Fund Growth
Businesses need money to grow (build factories, hire marketers, develop software). They have to get this capital from somewhere.
Debt is generally cheaper but riskier. If you take out a massive bank loan and your new product fails, the bank can force you into bankruptcy.
Equity is safer but more expensive. If you sell 20% of your company to a venture capitalist and the product fails, you don't owe them a refund. But if the company becomes the next Google, you just gave away billions of dollars.
Companies constantly balance Debt and Equity to find their optimal "Cost of Capital." When a CMO proposes a $2 Million marketing campaign, the CEO is thinking: "Our cost to borrow that $2M is 8%. Will this marketing campaign generate a return higher than 8%? If not, we are destroying value."
