Capital Budgeting and Cost of Capital: A Unique Formulation of the Main Investment Decision Methods

Abstract:     
Analysts can use various methods to value an investment project including the standard weighted average cost of capital (WACC) method, the Arditti-Levy method, the equity residual method, and the Adjusted Present Value. We propose a unique formulation from which these methods can be derived. This formulation permits demonstrating the equality of their net present values and the consistency of their internal rates of return in a straightforward manner when a predetermined debt ratio is targeted. We also discuss possible pitfalls and adjustments when considering a project's financing mix.

Number of Pages in PDF File: 12

Keywords: Capital Budgeting, Cost of Capital, WACC, NPV, IRR, APV

JEL Classification: G30, G31, G32

working papers series