Concept of cost of capital
Wren Manufacturing is in the process of analyzing its investment decision-making procedures. The two projects evaluated by the firm during the past month were projects 263 and 264. The basic variables surrounding each project analysis and the resulting decision actions are summarized in the following table.
Basic variables Project 263 Project 264
Cost $64,000 $58,000
Life 15 years 15 years
Expected return 8% 15%
Least-cost financing
Source Debt Equity
Cost (after-tax) 7% 16%
Decision
Action Invest Don't invest
Reason 8%>7% cost 15%<16% cost
a. Evaluate the firm's decision-making procedures, and explain why the acceptance of project 263 and rejection of project 264 may not be in the owners' best interest.
b. If the firm maintains a capital structure containing 40% debt and 60% equity, find its weighted average cost using the data in the table.