Methodologies for Determining the Opportunity Cost of Capital: Financing in the Selection of Investments

Abstract

Objective: The objective of this study is to determine the rate of opportunity cost of capital and analyse project financing, within the scope of concepts and techniques in investment analysis and evaluation. Theoretical Framework: The concept of "opportunity cost of capital" is presented, as well as the methodologies for determining the rate of cost of capital for analysing and evaluating investments that business management faces, whether in new investments or in financing the growth of its current activity. Method: A descriptive method is appropriate to the objective and relates the theoretical framework for determining the cost of capital to decision-making and investment financing. Results: How the cost of capital is calculated in the various methodologies is detailed, highlighting the adequacy of the methodologies to the specific circumstances. An example is given of how to consider financing in cost of capital methodologies, emphasising that the value created by an investment does not derive from financing. Conclusion: The methodologies for determining the cost of capital for different financing structures are discussed and clarified. The difference between methodologies for determining the cost of capital and determining the present value of tax benefits from financing is demonstrated, making it clear that value creation results from the investment and not tax benefits from financing.