Final answer:
The cost of capital, also known as capital charge, refers to the rate of return required by a firm to invest its financial capital. It includes the interest rate on other financial investment opportunities and any applicable risk premium. It is calculated based on the opportunity cost of using the firm's capital in a specific investment.
Step-by-step explanation:
The cost of capital, also known as capital charge, is the rate of return required by a firm to invest its financial capital. It represents the opportunity cost of using the firm's capital in a particular investment. The cost of capital is calculated by taking into account the interest rate on other available financial investment opportunities, as well as any risk premium that may be applicable.
For example, if the interest rate in the market is 9% and a firm can capture a 5% return to society, the firm would invest as if its effective rate of return is 4%. This means that the firm would invest $183 million if the investment is valued at $102 million.