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Capital budgeting: Why borrow at 7% to only earn 5%?

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Please help with the following finance problem. Provide at least 200 words in the solution.

Pertaining to capital budgeting, why would you borrow at 7% if you are only going to earn 5%? Could this be logical since revenue changes all the time?

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Solution Summary

The following posting helps with a capital budgeting problem. This discussion is in everyday language, free of buzz words and terminology usually surrounding this issue, so that novices can get the idea without having any background in the discipline. The discussion talk about the classic or normal answer to this question and the potential exceptions to the rule. The explanation is given in 248 words.

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Normally, you would not. If you can't earn enough to cover the cost of capital, you would reject the project. So, it would be rare to borrow at 7% if you are expecting to earn 5% return on investment.

With that said, you might do this in special cases. When? If you believe that one or both of these metrics will change or are difficult to ...

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Carol Sargent, PhD
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  • MSc, University of Virginia
  • PhD, Georgia State University
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