Formula for the Opportunity Cost of Capital
The required rates of return are market-determined. They are established in the capital markets by the actions of competing investors. The influence of market is direct in the case of new issue of ordinary and preference shares and debt.
The market price of securities is a function of the return expected by investors. The demand and supply force in such a way that equilibrium rates are established for various securities. Thus opportunity cost of capital is given by the following formula,
Where Io is the capital supplied by investors in period 0 (it represents a net cash inflows to the firm) Ct are returns expected by investors (they represent cash outflows to the firm) and k is the required rate of return or the cost of capital.
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