Specific Cost of Capital

When the Cost of every source of capital is individually calculated, it is known as Specific Cost of Capital example Cost of equity, cost of debt, etc.  For the purpose of capital budgeting decisions, benefits from proposed project are evaluated on an after tax basis.  Cost of Capital have three components:

1)The risk-less cost of the particular type of financing (r )

 2)The business risk premium (b) and

3)The financial risk premium (f)

The specific cost will point out the relative cost of pursuing one type of financing rather than another. From the analysis of Capital budgeting decisions, the long term sources of funds are appropriate as they constitute most important source of financing of fixed assets.  The exact costs have to be calculated for  (1) Long term Debt (including debentures) (2) Preference shares (3) Equity capital and (4) Retained earnings.