Question 8.RQ.3: Should the specific cost of raising finance for a particular...
Should the specific cost of raising finance for a particular project be used as the appropriate discount rate for investment appraisal purposes? Why?
It would not be appropriate to employ the specific cost of raising capital for an investment project as the appropriate discount rate. The use of such an approach could result in bizarre decisions being made. Projects with an identical return may be treated differently according to the particular cost of raising finance for each project. It is better to view the individual elements of capital as entering a pool of funds and thereby losing their separate identity.
The cost of capital used for investment decisions will represent the average cost of the pool of funds. It should also be remembered that individual elements of capital are interrelated.
It would not be possible, for example, to raise debt unless the business had a reasonable level of ordinary share capital. To treat each source of capital as being quite separate is therefore incorrect