Definition
Capital charge is the dollar cost of capital applied to invested capital. It is used in EVA and value-based performance analysis.
Formula
Capital charge = invested capital * cost of capital
Example
Invested capital $5M with 10% cost of capital gives a $500k charge.
How to use it
- Use after-tax cost of capital to align with after-tax cash flows.
- Compare operating profit to the charge to assess value creation.
Common mistakes
- Using book capital that excludes off-balance sheet investments.
- Mixing pre-tax profits with after-tax cost of capital.
Measured as
Capital charge = invested capital * cost of capital
Misused when
- Using book capital that excludes off-balance sheet investments.
- Mixing pre-tax profits with after-tax cost of capital.
Operator takeaway
- Use after-tax cost of capital to align with after-tax cash flows.
- Compare operating profit to the charge to assess value creation.
- Tie Capital Charge to the same balance-sheet date, scenario, and decision memo you are using elsewhere in the model.
- Document which claims, costs, or adjustments your team includes before comparing numbers across forecasts, covenants, or valuation work.
Next decision
- Read WACC explained: how to estimate a discount rate for DCF if the decision depends on interpretation, policy, or trade-offs beyond the raw formula.
- Decide whether Capital Charge belongs in cash planning, valuation, or debt monitoring so the number is used in the right model.
Where to use this on MetricKit
Guides
- WACC explained: how to estimate a discount rate for DCF: A practical guide to WACC: what it is, how to compute it, and how to use it (carefully) as a DCF discount rate.
- DCF valuation: forecast cash flows, discount rate, and terminal value: A practical guide to DCF valuation and WACC discount rate choices: how to forecast FCF, choose a discount rate, and avoid terminal value traps.