debt, preferred stock, and common equity.

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The cost of capital is an important measure for businesses, as it is used to determine the rate at which they can borrow funds and invest in projects. It is computed by taking a weighted average of the three major components that make up a company’s sources of financing: debt, preferred stock, and common equity. Each component is given a weight based on its proportion to total capitalization.

Debt typically carries the highest weight since companies generally have more debt than equity or preferred stock. The cost of this component (which usually takes the form of interest payments) can be determined by looking at recent borrowing costs from similar organizations and adjusting according to any risk premiums associated with the particular organization.

Preferred stock has a lower weighting than debt but higher than common equity since it provides investors with some protection against losses due to bankruptcy but still allows them to receive dividends before any payments are made to common shareholders. Its cost can be calculated using dividend yields from comparable securities issued by other organizations and adjusted accordingly.

Finally, common equity carries the lowest weighting but also tends to have the highest return requirement due to its lack of contractual obligations between shareholders and corporations. Cost here can be estimated using an equity risk premium multiplied by market returns on stocks.

Overall, computing cost of capital requires companies to weigh each source of financing carefully in order to ensure they are obtaining enough funding while not overextending themselves too much financially so as not put their operations into jeopardy in case something goes wrong