acc560 week 8 discussion 2

acc560 week 8 discussion 2 - company is using the net...

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Discuss the term “cost of capital” and its relevance to decision making in an organization. Cost of capital is a broad concept, involving a blending of the costs of all sources of investments funds, both debt and  equity.  In most instances a company used a required rate of return equal to its cost of capital - that is, the rate that it  must pay to obtain from creditors and stockholders.  The cost of capital is known by various names.  Besides being  called the required rate of return, it is sometimes called the hurdle rate, or the cutoff rate.    The cost of capital can operate as a screening tool, helping the manager to screen out undesirable investment  projects and then to make decision.   This screening is accomplished in different ways, depending on whether the 
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Unformatted text preview: company is using the net present value method (NPV), the internal rate of return method (IRR), annual rate of return method, or payback period method in its capital budgeting analysis. Take examples for NPV and IRR methods. When the net present value method is used, the cost of capital becomes the discount rate used to compute the net present value of a proposed project. Any project yielding a negative net present value is screened out and rejected. On the other hand, when the internal rate of return method is used, the cost of capital takes the form of a hurdle rate that a project must clear for acceptance. If the internal rate of return on a project is not great enough to clear the cost of capital hurdle, then the project is rejected....
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