Which basic metric reflects the minimum return required given alternative investments?

Which basic metric reflects the minimum return required given alternative investments?

• A. Cost of Capital
• B. Discount rate
• C. Market return
• D. Tax rate

Answer: (A)

The cost of capital represents the minimum return required on an investment given its risk and the alternative uses of funds. It captures the mix of debt and equity that a company must pay to obtain financing, effectively the opportunity cost of capital. In capital budgeting, this rate serves as the hurdle you compare project cash flows against: if the project’s expected return (or IRR) exceeds the cost of capital, it should add value; if it falls short, it likely destroys value. The discount rate is closely related and is often set to the cost of capital in practice, but the fundamental idea of a minimum acceptable return tied to the opportunity cost of capital makes cost of capital the best answer. Market return is a market-wide benchmark and doesn’t specify the required return for a specific investment, and tax rate affects cash flows but not the minimum return threshold itself.

The cost of capital represents the minimum return required on an investment given its risk and the alternative uses of funds. It captures the mix of debt and equity that a company must pay to obtain financing, effectively the opportunity cost of capital. In capital budgeting, this rate serves as the hurdle you compare project cash flows against: if the project’s expected return (or IRR) exceeds the cost of capital, it should add value; if it falls short, it likely destroys value. The discount rate is closely related and is often set to the cost of capital in practice, but the fundamental idea of a minimum acceptable return tied to the opportunity cost of capital makes cost of capital the best answer. Market return is a market-wide benchmark and doesn’t specify the required return for a specific investment, and tax rate affects cash flows but not the minimum return threshold itself.