{"id":1540,"date":"2019-09-12T13:33:00","date_gmt":"2019-09-12T13:33:00","guid":{"rendered":"https:\/\/analystprep.com\/cfa-level-1-exam\/?p=1540"},"modified":"2026-03-19T17:22:09","modified_gmt":"2026-03-19T17:22:09","slug":"marginal-cost-capital","status":"publish","type":"post","link":"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-finance\/marginal-cost-capital\/","title":{"rendered":"The Marginal Cost of Capital"},"content":{"rendered":"\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"Calculate NPV given cash flows and 5% discount rate\",\n    \"text\": \"Company XYZ is considering an investment of $50 million in a project. The project will return after-tax cash flows of $15 million per year for the first 2 years and another $35 million in year 3, the final year of the project. If the company\u2019s marginal cost of capital is 5%, the NPV of the project is closest to:\\n\\nA. $8.125 million.\\n\\nB. $20.245 million.\\n\\nC. $13.115 million.\",\n    \"answerCount\": 1,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"The correct answer is A.\\n\\nNPV = 15\/(1.05)^1 + 15\/(1.05)^2 + 35\/(1.05)^3 \u2212 50 = 14.286 + 13.605 + 30.234 \u2212 50 = 8.125 million.\"\n    }\n  }\n}\n<\/script>\n\n<script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"VideoObject\",\n  \"name\": \"Cost of Capital (2021 Level I CFA\u00ae Exam \u2013 Reading 33)\",\n  \"description\": \"This CFA Level I video on Corporate Finance covers the cost of capital, including how to calculate WACC, cost of equity, and cost of debt. It explains CAPM, DDM, and bond yield approaches, tax impacts, beta estimation, marginal cost of capital, and flotation costs with practical examples and formulas.\",\n  \"uploadDate\": \"2018-10-21T00:00:00+00:00\",\n  \"thumbnailUrl\": \"https:\/\/img.youtube.com\/vi\/I_SgGrDv1YM\/maxresdefault.jpg\",\n  \"contentUrl\": \"https:\/\/www.youtube.com\/watch?v=I_SgGrDv1YM\",\n  \"embedUrl\": \"https:\/\/www.youtube.com\/embed\/I_SgGrDv1YM\",\n  \"duration\": \"PT33M52S\"\n}\n<\/script>\n\n\n\n<iframe loading=\"lazy\" width=\"560\" height=\"315\" src=\"https:\/\/www.youtube.com\/embed\/I_SgGrDv1YM?si=XpeVauVpRcSyXQR6\" title=\"YouTube video player\" frameborder=\"0\" allow=\"accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share\" referrerpolicy=\"strict-origin-when-cross-origin\" allowfullscreen><\/iframe>\n\n\n<p>The cost of capital should ideally reflect the riskiness of the future cash flows of a project. For an average-risk project, the opportunity cost of capital is the same as the weighted average cost of capital (WACC) of the company. If the risk of the project is above or below average, then an upward or downward adjustment should be made to the WACC of the company.<\/p>\n<p>The marginal cost of capital corresponds to the average risk of a company while appropriately adjusting to the riskiness of a given project. It plays a key role in capital budget decision-making based on the net present value (NPV) of the project.<\/p>\n<h2><strong>Determining the Net Present Value (NPV) of a Project<\/strong><\/h2>\n<p>You may recall that NPV = Present value of cash inflows \u2013 Present value of cash outflows<\/p>\n<p>If a project\u2019s NPV &gt; 0, a company should undertake the project, while if NPV &lt; 0, the project should not be undertaken.<\/p>\n<p>If the the WACC of a company is used in the calculation of the NPV of a project, the assumption being made is that the project:<\/p>\n<ul>\n<li>has the same level of risk as the average-risk project of the company; and<\/li>\n<li>will have a constant target capital structure for the entirety of its useful life.<\/li>\n<\/ul>\n<blockquote>\n<h2><strong>Question<\/strong><\/h2>\n<p>Company XYZ is considering an investment of $50 million in a project. The project will return after-tax cash flows of $15 million per year for the first 2 years and another $35 million in year 3, the final year of the project. If the company\u2019s marginal cost of capital is 5%, the NPV of the project is <em>closest<\/em> to:<\/p>\n<ol style=\"list-style-type: upper-alpha;\">\n<li data-tadv-p=\"keep\">$8.125 million.<\/li>\n<li data-tadv-p=\"keep\">$20.245 million.<\/li>\n<li data-tadv-p=\"keep\">$13.115 million.<\/li>\n<\/ol>\n<p><strong>Solution<\/strong><\/p>\n<p>The correct answer is <strong>A<\/strong>.<\/p>\n<p>$$ \\begin{align*}<br \/>\\text{NPV} &amp; = \\cfrac {15}{1.05^{1}}+ \\cfrac {15}{1.05^{2}}+\\cfrac {35}{1.05^{3}} -50 \\\\<br \/>&amp; = 14.286 + 13.605 + 30.234 \u2013 50 = $8.125 \\text{ million} \\\\<br \/>\\end{align*} $$<\/p>\n<\/blockquote>\n<div class=\"notes_inv\"><hr \/>\n<p><a href=\"https:\/\/analystprep.com\/cfa-level-1-exam\/corporate-finance\/learning-sessions-curriculum-corporate-finance\/\"><em>Corporate Finance &#8211; Learning Sessions<\/em><\/a><\/p>\n<\/div>","protected":false},"excerpt":{"rendered":"<p>The cost of capital should ideally reflect the riskiness of the future cash flows of a project. For an average-risk project, the opportunity cost of capital is the same as the weighted average cost of capital (WACC) of the company&#8230;.<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[6],"tags":[],"class_list":["post-1540","post","type-post","status-publish","format-standard","hentry","category-corporate-finance","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.4 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Marginal Cost of Capital Explained | CFA Level 1<\/title>\n<meta name=\"description\" content=\"Learn about the marginal cost of capital, its formula, and its role in corporate finance. 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