7.4 MARGINAL COST OF CAPITAL
The weighted average cost of capital or the average cost of capital indicates to large extent the historical cost of capital. It is very relevant for comparing the actual cost of funds with some pre-determined standards of cost of capital. However, while making capital budgeting decisions, the firm is in need of additional funds that represent the cut-off rate, and not the historical cost of additional funds raised for making investments.
The computation of marginal cost of capital involves the process of calculating the cost of different types of additional capital required. Then marginal weight is assigned to each of them which is computed on the basis of the proportion of different types of additional capital required. ...
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