Problem:
After looking at the project and talking with some people that have been around the organization for many years, you recognize that the 10% cost of capital is not reflective of the company's current cost of capital. The head of treasury has assured you that the company can raise debt at 7% in today's market and that if the firm was not going to use the US$4M to invest in the machine for the production plant, it would be invested in some short-term securities yielding 5%.
With this in mind, explain a company's cost of capital and how it is calculated. What is marginal cost of capital and how does it differ from weighted average cost of capital? How do market rates and the company's perceived market risk impact its cost of capital? Assume you are leading a discussion on these elements with the managers and finance personnel.