Reference no: EM132978985

Question - You are the personal assistant of the managing director of a company. The board of directors has agreed that all investment projects should be evaluated using net present value (NPV) as the accept/reject criterion. As a further requirement it has been agreed that NPV should be computed using the company's weighted average cost of capital, which the company's finance director has determined as 25 percent. One of the divisional heads seeks the managing director's approval for financing one of his divisional projects entirely with debt secured upon the project's assets. She argues that doing so is advantageous because this finance can be secured at a rate of only 6 percent. The divisional head proposes that the project's NPV should therefore be evaluated using a 6 percent rate.

Explain to the managing director what is meant by "weighted average cost of capital" and how it is computed. Please explain why it generally makes sense to use this as the hurdle rate when evaluating investment proposals and the circumstances when a different rate should be used. Is the divisional manager's preference for using the debt financing rate such a reason.