Question: Why do we use the overall cost of capital for investment decisions even when only one source of capital will be used (e.g., debt)? (LO11-1)
The overall cost of capital is used for investment decisions as debt is a much riskier option of raising funds.
Investment is a process of setting aside money in the form of assets to earn periodic income or to accumulate fund for future.
The business uses the overall cost of capital for investment decisions even though investment is usually financed by low-cost debt because it might appear very acceptable at first look. But, on the other hand, the use of debt could increase the risk to the firm. So, each project must be measured against the overall cost of funds to the firm.
North Pole Cruise Lines issued preferred stock many years ago. It carries a fixed dividend of $6 per share. With the passage of time, yields have soared from the original 6 percent to 14 percent (yield is the same as required rate of return).
a. What was the original issue price?
b. What is the current value of this preferred stock?
c. If the yield on the Standard & Poor’s Preferred Stock Index declines, how will the price of the preferred stock be affected?
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