Cost of Capital

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Keeping money in the bank is an advice that is good for individuals, but bad for companies. Why is that?

By keeping the money in the bank your money is worth less each day see here for an explanaion

This is not acceptable for companies or shareholders. If there is cash available it should be used for something that generates more cash, and at the time of this article, bank account return less than 0.5% each year (i.e. money will devaluate each year), so it is not a good option.

It is a company’s job (CFO really) to find a way to grow the cash. That might be re-investing in the company, lend it to customers with delayed payment terms, buying in the stock exchange (risky!) or any of the many financial option available.

The % that a company/shareholders estimate it could/should make by investing the money is called cost of capital. This potential return on cash is used by the C-team to authorize (or not) project to move forward. The question they ask the numbers is: “by investing now in this project, will we have a better return than our cost of capital?”

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