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.

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

JEL Classification: G30, G31, G32