Question

The average cost of capital is:

the same for all companies

all of these

fixed through time

a benchmark for accepting or rejecting projects.

Answer 1

The average Cost of Capital is the rate of interest which the companys pays to finace its assets. It is usually comprised of a combination of Debt Equity and Other Instruments.

Avererage Cost of Capital cannot be the same for all companies. Some companies can be levered whereas others may be totally equity financed. Therefore Cost of Capital Cannot be the same for all companies.

Moreover Cost of Capital Changes as and when the rates or weights (or both) of equity, debt and other instruments used by the company to finance its its assets changes. For eg, a completely unleevered company decides to borrow debt and therefore its cost of capital changes. Therefore cost of capital is not fixed.

Now, Cost of Capital as mentioned earlier is the rate of retrun which the company pays to finance its assets. Now if any project is genereating return higher than its avereage cost of capital, it means that it has a positive NPV and therefore accepting the project is a viable option. Now, if the project return is less than its cost of capital, theis means that NPV is negative and therefore teh project should not be selected.

Answer Therefore Cost of Capital is a benchmark for selecting or rejecting a project.