Capital budgeting involves decisions about whether or not to invest in fixed assets, and it has a major influence on firms' future performances and values. Discounted cash flow analysis is used in capital budgeting, and a key element of this procedure is the discount rate used in the analysis. Capital must be raised to finance fixed assets, and this capital comes from different sources: debt, preferred stock, and common equity. Each of these capital components has a cost, and these cost rates, along with the target proportions of each, are used to calculate the firm's weighted average cost of capital or "WACC."
After you have completed the above, answer the following question:
Identify some problem areas in the cost of capital analysis. Do these problems invalidate the cost of capital procedures we are discussing in this unit?