Chapter 10, Section 10-10, SelfTest, Exercise 10
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Identify some problem areas in cost of capital analysis. Do these problems invalidate the cost of capital procedures discussed in this chapter? Explain.

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Cost of capital analysis should be viewed  as an indication and adjusted to different scenarios. 


Although potential problems exists, cost of capital analysis is still an important basis for capital budgeting. Many of the problems can be remedied with cautious procedures. For example, a comparable public firm can be used as a reference for a privately-owned firm and a data problem can be addressed by relying on big data analysis nowadays. It can also be flexible to adjust for projects of different levels of risk. Therefore, the importance of cost of capital analysis should not be discounted.

Verified Answer

  1. Accounting treatment of depreciation costs
  2. Data availability for certain types of firms
  3. Measurement problems resulting from estimation error
  4. Adjustments for different risk levels
  5. Decisions about capital structure weights
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