Question

When companies consider investing in a project, they determine the impact of this decision on their...

When companies consider investing in a project, they determine the impact of this decision on their overall cost of capital.

  • Why do companies use the overall cost of capital for investment decisions even when only one source of capital will be used for the specific project under consideration?
  • Discuss.

When computing this cost of capital, does the firm use the historical costs of existing debt or the current costs as determined by the market?

  • Why?
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Answer #1

Company are using the overall cost of capital for investment decision even if there is one source of capital which will be used for a specific project because the company will be using the overall cost of capital of its own. Cost of capital,Which company will be using the cost of capital of the company and not the specific project.

When computation of the cost of capital is done, we will be using the market cost of debt capital because it will be trying to take the present value of debt capital in order to have a better clarity about decision making because historical cost of debt will not be reflective of its true price because there are trading at premium or discount and bond yields are also changing.

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