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Financing decision

How do I answer this without knowing risk or any other information.

Your boss is considering borrowing $10,000 from a bank at 8% for a project.
She has determined that the rate of return on the project is expected to be 12%. She
comments that since the project is earning more than the cost of the debt, it should
definitely be undertaken. You assert that the company's average cost of capital is
13% and the project should not be undertaken. Surprised with your assertiveness she
replies, "I don't care about the average cost of capital. I am only using this debt to
finance the project. Since this debt only costs 8%, and the project should earn 12%,
it will be profitable!!" Defend your assertion that the project should not be


Solution Preview

The financing decision determines the financial risk of the business. In general the greater proportion of long term debt in the capital structure of the firm the greater is the financial risk ...

Solution Summary

This solution explains the concept of financing decision.