FM11 47 - This increased cost of capital may cause you to...

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Mini Case: 11 - 47 m. After examining all the potential projects, you discover that there are many more projects this year with positive NPVs than in a normal year. What two problems might this extra large capital budget cause? You only have a limited amount of capital to commit to projects. If you have to raise external capital to fund some of these other positive NPV projects, then you may be faced with an increasing cost of capital. This is called an increasing marginal cost of capital schedule, and it also happens to companies when they exhaust their internal sources of funds and have to go to external capital markets for their finding.
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Unformatted text preview: This increased cost of capital may cause you to reject projects that you might otherwise accept because with your increased cost of capital, some projects may be negative NPV when they would otherwise be positive NPV in a normal year. Another effect of this large capital budget is that you may choose to ration capital i.e. not fund all of the projects. This is called capital rationing, and companies and investors do this when for whatever reason they put a cap on the funds they are willing to invest in new projects....
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