P.8. Opportunity cost of capital. F&H Corp. continues to invest heavily in a declining industry. Here...

60.1K

Verified Solution

Question

Finance

P.8. Opportunity cost of capital. F&H Corp.continues to invest heavily in a declining industry. Here is anexcerpt from a recent speech by F&Hâ€™s CFO:
Â Â Â
Â Â Â Â Â We at F&H have ofcourse noted the complaints of a few spineless investors anduninformed security analysts about the slow growth of profits anddividends. Unlike those confirmed doubters, we have confidence inthe long-run demand for mechanical encabulators, despite competingdigital products. We are therefore determined to invest to maintainour share of the overall encabulator market. F&H has a rigorousCAPEX approval process, and we are confident of returns around 8%on investment. Thatâ€™s a far better return than F&H earns on itscash holdings. The CFO went on to explain that F&H investedexcess cash in short-term U.S. government securities, which arealmost entirely risk-free but offered only 4% rate ofreturn.
a. Is a forecasted 8% return in the encabulator businessnecessarily better than a 4% safe return on short-term U.S.government securities? Why or why not?
b. Is F&Hâ€™s opportunity cost of capital 4%? How inprinciple should the CFOdetermine the cost of capital?

Answer & Explanation Solved by verified expert

3.8 Ratings (422 Votes)

a Is a forecasted 8 return in the encabulator business necessarily better than a 4 safe return on shortterm US government securities Not necessarily when compared to higher See Answer

Get Answers to Unlimited Questions

Join us to gain access to millions of questions and expert answers. Enjoy exclusive benefits tailored just for you!

Membership Benefits:

Unlimited Question Access with detailed Answers
Zin AI - 3 Million Words
10 Dall-E 3 Images
20 Plot Generations
Conversation with Dialogue Memory
No Ads, Ever!
Access to Our Best AI Platform: Flex AI - Your personal assistant for all your inquiries!

Become a Member