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)

Question

Want to see more full solutions like this?

Answer 1

Textbook Question

Chapter 11, Problem 1DQ

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)

Expert Solution & Answer

Summary Introduction

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.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Students have asked these similar questions

Replacement Analysis The Everly Equipment Company's flange-lipping machine was purchased 5 years ago for $75,000. It had an expected life of 10 years when it was bought and its remaining depreciation is $7,500 per year for each year of its remaining life. As older flange-lippers are robust and useful machines, this one can be sold for $20,000 at the end of its useful life. A new high-efficiency digital-controlled flange-lipper can be purchased for $130,000, including installation costs. During its 5-year life, it will reduce cash operating expenses by $45,000 per year, although it will not affect sales. At the end of its useful life, the high-efficiency machine is estimated to be worthless. MACRS depreciation will be used, and the machine will be depreciated over its 3-year class life rather than its 5-year economic life, so the applicable depreciation rates are 33.33%, 44.45%, 14.81%, and 7.41%. The old machine can be sold today for $50,000. The firm's tax rate is 25%, and the…

The Gilbert Instrument Corporation is considering replacing the wood steamer it currently uses to shape guitar sides. The steamer has 6 years of remaining life. If kept, the steamer will have depreciation expenses of $700 for 5 years and $350 for the sixth year. Its current book value is $3,850, and it can be sold on an Internet auction site for $4,440 at this time. If the old steamer is not replaced, it can be sold for $800 at the end of its useful life. Gilbert is considering purchasing the Side Steamer 3000, a higher-end steamer, which costs $12,300, and has an estimated useful life of 6 years with an estimated salvage value of $1,200. This steamer falls into the MACRS 5-years class, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The new steamer is faster and allows for an output expansion, so sales would rise by $2,000 per year; the new machine's much greater efficiency would reduce operating expenses by $1,800 per year. To support the…

St. Johns River Shipyards' welding machine is 15 years old, fully depreciated, and has no salvage value. However, even though it is old, it is still functional as originally designed and can be used for quite a while longer. A new welder will cost $181,500 and have an estimated life of 8 years with no salvage value. The new welder will be much more efficient, however, and this enhanced efficiency will increase earnings before depreciation from $28,000 to $78,500 per year. The new machine will be depreciated over its 5-year MACRS recovery period, so the applicable depreciation rates are 20.00%, 32.00%, 19.20%, 11.52%, 11.52%, and 5.76%. The applicable corporate tax rate is 25%, and the project cost of capital is 13%. What is the NPV if the firm replaces the old welder with the new one? Do not round intermediate calculations. Round your answer to the nearest dollar. Negative value, if any, should be indicated by a minus sign.

Answer 2

Textbook Question

Chapter 11, Problem 1DQ

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)

Expert Solution & Answer

Summary Introduction

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.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 3

Textbook Question

Chapter 11, Problem 1DQ

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)

Expert Solution & Answer

Summary Introduction

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.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 4

Textbook Question

Chapter 11, Problem 1DQ

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)

Expert Solution & Answer

Summary Introduction

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.

Want to see more full solutions like this?

Subscribe now to access step-by-step solutions to millions of textbook problems written by subject matter experts!

Answer 5

Textbook Question

Answer 6

Textbook Question

Answer 7

Expert Solution & Answer

Summary Introduction

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.

Answer 8

Expert Solution & Answer

Summary Introduction

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.

Answer 9

Expert Solution & Answer

Answer 10

Expert Solution & Answer

Answer 11

Summary Introduction

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 12

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.

Answer 13

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.

Answer 14

Ch. 11 - Why do we use the overall cost of capital for...Ch. 11 - How does the cost of a source of capital relate to...Ch. 11 - Prob. 3DQ Ch. 11 - Why is the cost of debt less than the cost of...Ch. 11 - What are the two sources of equity (ownership)...Ch. 11 - Explain why retained earnings have an associated...Ch. 11 - Why is the cost of retained earnings the...Ch. 11 - Why is the cost of issuing new common stock Kn...Ch. 11 - How are the weights determined to arrive at the...Ch. 11 - Explain the traditional, U-shaped approach to the...

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)

Concept explainers

Videos

Answer to Problem 1DQ

Explanation of Solution

Want to see more full solutions like this?

Chapter 11 Solutions