The Concepts of Weighted Average Cost of Capital and Marginal Cost of Capital

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There is some confusion between the concepts of weighted average cost of capital and marginal cost of capital. We have seen that the weighted average cost of capital is the basis for the 10% discount rate that was used to evaluate the project. The weighted average cost of capital reflects the firm's cost of capital, and that includes both debt and equity. This is a more accurate figure to use in the calculation of a project's value than the marginal cost of capital. The marginal cost of capital is the cost to the firm of an additional unit of capital (Investorwords, 2012). In this case, the marginal cost of capital is the 7% that we would pay on new debt. This is different from the weighted average cost of capital for a couple of reasons the first is that it assumes that the company is going to choose one type of capital over another. The second is that it is based on current market rates. The latter point is important because the WACC is based on historic costs to the firm, and the understanding that on average future costs will be close to past costs. The market rate today is not necessarily indicative of the future costs of capital as market rates can be affected by any number of temporary phenomenon. It is also important to remember that the firm does have equity in its capital structure. Indeed, if we paid for this project out of cash, that would be a purchase out of equity. The reason the weighted average cost of capital is used is because it treats all projects

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