Illustrating Non-Constant Marginal Cost of Capital and the Interdependency of Independent Projects

Gutierrez, J., S. Johnson, and R. Stretcher. “Illustrating non-constant marginal cost of capital and the interdependency of independent projects.” Journal of Financial Education, vol. 41 (2015), pp. 11-31.

21 Pages Posted: 6 Mar 2013 Last revised: 29 May 2016

See all articles by Robert Stretcher

Robert Stretcher

Sam Houston State University

Jose A. Gutierrez

Sam Houston State University

Steve Johnson

Sam Houston State University

Date Written: March 6, 2013

Abstract

The simple mechanics of capital budgeting decision techniques are complicated by presence of mutual exclusion, project contingencies, differing risk levels, and unequal lives. This paper examines another such complexity virtually ignored by financial management textbooks but present in virtually all capital budgeting scenarios: project interdependency caused by a non-constant marginal cost of capital (MCC) schedule, a cost schedule representing the reality for business firms. Any capital budgeting decision method using the cost of capital as an input is affected. An example of this complexity is presented in this paper. An expositional exercise concerning the role of cashflow pattern and scale differences in creating differences in total net present value for a capital budgeting decision is presented as well. Finally, an explanation of the isolated role of the non-constant MCC is presented and a proof offered in the paper's appendix.

Suggested Citation

Stretcher, Robert and Gutierrez, Jose A. and Johnson, Steve, Illustrating Non-Constant Marginal Cost of Capital and the Interdependency of Independent Projects (March 6, 2013). Gutierrez, J., S. Johnson, and R. Stretcher. “Illustrating non-constant marginal cost of capital and the interdependency of independent projects.” Journal of Financial Education, vol. 41 (2015), pp. 11-31.. Available at SSRN: https://ssrn.com/abstract=2229396 or http://dx.doi.org/10.2139/ssrn.2229396

Robert Stretcher (Contact Author)

Sam Houston State University ( email )

1803 Ave I
Huntsville, TX 77341
United States
936-294-3308 (Phone)

Jose A. Gutierrez

Sam Houston State University ( email )

1803 Ave I
Huntsville, TX 77341
United States

Steve Johnson

Sam Houston State University ( email )

1803 Ave I
Huntsville, TX 77341
United States

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