Explain the relationship between the cost of capital, bond ratings, and the capital budgeting decision-making process

Abstract The purpose of this essay is to explain the relationship between the cost of capital, bond ratings, and the capital budgeting decision-making process. Cost of Capital Companies finance their operations by three mechanisms: Issuing stock (equity), issuing debt (borrowing from a bank is equivalent for this purpose), and reinvesting prior earnings. The cost of capital for a firm is a weighted sum of the cost of equity and the cost of debt. Re-invested money …

…may change over the life of the project affecting the viability of the project b. technology may change rendering the product obsolete (reduced expected life of project) c. competition may alter demand and therefore the assumptions of cash flow for the project ( reduce expectation of cash flow) References: Retreived from About.com, on 07/10/2006, http://economics.about.com/cs/economicsglossary/g/bond_rating.htm Block−Hirt: Foundations of Financial Management, The McGraw − Hill Companies, 2004