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Financial Managers and Overall Cost of Capital

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1. Why would a financial manager use the overall cost of capital for investment decisions when the decision may be funded by only one source of capital, (e.g., debt or equity)?

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The solution determines why a financial manager would use an overall cost of capital for investment decisions when the decision may be finded by only one source of capital.

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Cost of capital is defined as the required return necessary to make a capital budgeting project worthwhile. Cost of capital would include the cost of debt and the cost of equity. Higher debt lowers the cost of capital up to a certain point, but after that it increases the cost of capital due to the higher costs of financial distress. Thus, a financial manager must also examine if the chosen debt-equity ratio ...

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