Cost of capital generally refers to the cost of a company’s funds that are required to undertake a particular project, this can be either debt or equity. Personal cost of capital and corporate cost of capital do not vary greatly with the main difference being the amounts involved therein and the number of people usually involved in the decision-making process. Personal cost of capital also has a limited variety of options with regards to the types of funding available for the given project. When an individual considers investing in their education, the cost of capital is a huge determinant coupled with the expected returns once the individual finishes their education and begins working and earning. If loans were used to finance the education, one expects to earn enough money to pay back the loan comfortably. This need to recover the cost of education can be compared to a firm’s need to make profit. For businesses, every venture undertaken must be able to cover its costs and make profits if the firm is to stay in business and be able to meet its other financial obligations such as taxes and salaries.
Whether to use debt or equity (savings) for a project is a decision both families and firms have to make. Tax issues highly influence this decision as they can significantly alter the final cost of capital. A policy that lowers the limit on deductibility of interest expense on student loans increases the total cost of the loan. A huge loan amount means that the loanee will have to pay higher premiums leaving them with a smaller income for their other needs. Such a move would see many people prefer not to take loans to pay for their education and use their savings. Individuals with higher incomes would also be more willing to take on debt as they will be able to pay the premiums comfortably compared to those with a smaller income. However, considering that many American households do not have significant savings, many people will still be forced to take out student loans and be saddled with the heavy premiums they will be required to pay, at least it is not required in a lumpsum ( Supanantaroek, Lensink & Hansen, 2017). In the same breadth, firms may prefer to use debt to finance a project and use any savings they have as a bargaining chip to access the debt. The interest associated with the debt is factored into the costs of capital. For both personal and corporate cases, debt would be a more preferable source of capital with those involved seeking out packages that offer them better repayment terms and conditions.
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Reference
Supanantaroek, S., Lensink, R., & Hansen, N. (2017). The Impact of Social and Financial Education on Savings Attitudes and Behavior Among Primary School Children in Uganda. Evaluation Review, 41(6), 511–541. https://doi.org/10.1177/0193841X16665719
