Concept explainers
Why do we use the overall cost of capital for investment decisions even when only one source of capital will be used (e.g., debt)? (LO11-1)
To explain: The reason for using the overall cost of capital in order to make the decisions related to investments even though only one capital source is used.
Introduction:
Cost of Capital:
It refers to the rate of return paid by a company to its shareholders on investments and is helpful in the evaluation of investment opportunities.
Answer to Problem 1DQ
Financing through low-cost debt is the first priority for any firm as the use of debt might be riskier to the firm and can make financing costlier. Thus, every project should be measured keeping the total cost of funds aside to make effective investment decisions.
Explanation of Solution
An investment to be financed through low-cost debt must be acceptable by the firm right in the beginning but its use could increase the overall risk for the firm, thus increasing the cost of all the types of financing. Thus, every project should be estimated thoroughly keeping the total cost of the funds aside.
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Chapter 11 Solutions
Foundations of Financial Management
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