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THE LAST DECADE has produced some important advances in the theory of the cost of capital, particularly with respect to the two major sources of funds for corporate investment-retained earnings and long-term debt. The theory promises to be useful in corporate investment and financing decisions, in explaining the structure of asset valuation under uncertainty, and in providing information for macro-economic models that need values for such variables as the rate of profit investors require on risky assets. To realize this promise, however, the differences among the theoretical models that have been advanced must be resolved.Among the outstanding issues, perhaps the most important are whether the cost of debt and the cost of retained earnings are dependent upon or independent of a firm's debt and dividend policies. Here, just as in other areas of econometrics, the use of empirical methods to choose among the theories presents formidable problems, but two other reasons for the continued disagreement must be recognized. First, theories on the cost of each of these sources of capital have, with little exception, proceeded on the assumption that the source of capital in question is the only one. Second, the models employed to test the theories have typically been severely limited as representations of the theories.The purpose of this paper is to state the alternative theories on the cost of debt and retention capital in testable form, then to test these models using sample data drawn from the electric utility industry.