Concept of cost of capital

Wren Manufacturing is in the process of analyzing its investment decision-making procedures. The two projects evaluated by the firm during the past month were projects 263 and 264. The basic variables surrounding each project analysis and the resulting decision actions are summarized in the following table.

Basic variables                   Project 263          Project 264

Cost                                     $64,000                $58,000

Life                                     15 years                15 years

Expected return                       8%                       15%

Least-cost financing       

Source                                     Debt                   Equity      

Cost  (after-tax)                         7%                     16%

Decision

Action                                     Invest               Don't invest

Reason                              8%>7% cost        15%<16% cost

a. Evaluate the firm's decision-making procedures, and explain why the acceptance of project 263 and rejection of project 264 may not be in the owners' best interest.

b. If the firm maintains a capital structure containing 40% debt and 60% equity, find its weighted average cost using the data in the table.