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 is also charged at the cost of equity, since if the money is not reinvested is will normally be returned to shareholders. …
