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Unformatted text preview: s the cost of funds (from creditors and owners). This cost is the return required by
these suppliers of capital. The greater the risk of a project, the greater the return required, and hence,
the greater the cost of capital.
The cost of capital can be viewed as the sum what suppliers of capital demand for providing funds if the
project were risk-free plus compensation for the risk they take on.
The compensation for the time value of money includes compensation for any anticipated inflation. We
typically use a risk-free rate of interest, such as the yield on a long-term U.S. Treasury bond, to represent
the time value of money.
The compensation for risk is the extra return required because the project's future cash flows are
uncertain. If we assume that the relevant risk is the stand-alone risk (say, for a small, closely-held
business), investors would require a greater return, the greater the project's stand-alone risk. If we
assume that the relevant risk is the project's market risk, investors would require a greater return, the
greater the project's market risk. B. Return...
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This note was uploaded on 02/07/2014 for the course MIS 304 taught by Professor Mejias during the Spring '07 term at University of Arizona- Tucson.
- Spring '07