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How does the cost of capital affect capital investments that the firm makes? Cost of Capital refers to the amount of money a company spends to get its operations underway and in order to earn profit they must surpass this cost. This cost of capital is determined by and makes up its overall capital structure. A company adjusts its debts and equities within the capital structure to minimize the cost of capital. This balance is important because as a company takes on more debt, the costs are cheaper than equity but it increases the risk of default and at a certain point the premium associated with the risk becomes higher than the cost of introducing new equities. A firm must learn to balance these debts and equities in order to prevent higher premiums and lower the cost of capital. Some examples of types of firms with high costs of capital would be chemical companies as they require high amounts of capital for research equipment and factories. The low cost of capital firms would be financial services. To give an example of how a company's cost of capital affects its investments if a firm has the option of investing in debt that has an after-tax cost of 7% and 10% for equities, at some point the premium associated with that cheaper debt prevents a company from continuing to use debt and will introduce new equities. A split could be 70% debt 30% Equities. The total costs associated with each represents its cost of capital.