Cost of Capital in Investment Decisions

Which cost of capital should I use when valuing an investment? The aim of this book is to provide an answer for corporate finance managers industrial managers MBA or finance students who have faced this very dilemma. Finance theory explicitly advocates that firms use a project-specific discount rate when valuing investment projects or at least a rate specially tailored to each division within a multidivisional firm. Practitioners and scholars have designed a significant number of methods to compute such specific costs of capital ranging from high-flying approaches to very operational methods. And yet in a recent survey of US firms Graham and Harley (2001) showed that nearly 60% of responding companies said they use a single company-wide discount rate to evaluate new investment projects. The yawning gap between corporate finance theory and in-company finance practices will be illustrated by a technical study of the varied approaches and an exploration of past and current business practices.