Date of this Version
Cornhusker Economics, February 14, 2018, agecon.unl.edu/cornhuskereconomics
In capital budgeting, a firm must decide whether or not to invest in a project, such as a new machine, plant, or product. Typically, the firm will invest in the project if the present value of the stream of cash flows the project is expected to generate exceeds the project’s cost. The discount rate used in the present value calculation usually is the weighted average cost of capital for the firm, i.e., the weighted average of the firm’s costs of equity and debt. For publicly traded firms, the capital asset pricing model (CAPM) is the most commonly used means for estimating the cost of equity for use in capital budgeting decisions.