Week 6 Forum 2

Week 6 Forum 2
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Week 6 Forum 2
The cost of capital refers to the profit or loss expressed in percentage, which is required to convince the investor to make an investment. However, it is important to note that this is always determined by the market (Dixit & Pindyck, 1995). In this case, the investor is presented with two investment of the same risk which he then chooses one that will award the highest return.
One of the approaches used in determining the cost of capital is the subjective approach. This occurs when an investor uses personal opinions and educated guesses in making decision on certain investment. Some of the main advantages of this approach are; companies would not always have the luxury of providing a discount for every available project in an objective manner. Hence, in such situations, a company is more likely to adopt the subjective approach with respect to Weighed average cost of capital.
Additionally, the subjective approach helps in building risk groupings that are different and relative to the overall risk in the business. Moreover, the approach will subjectively give a risk adjustment factor to weighted average cost of capital to each risk grouping. Moreover, the approach utilizes the adjusted discount rates for the project centered on the risk grouping.
The reason as to why the subjective approach is finding footing among the investors is that there is believe that sometimes the market reacts excessively too bad and good.

Hence the stock prices do not match with a company’s long-term fundamentals. This presents a chance to make a profit when the prices are deflected. Hence, when an investor is presented with two or more investments that have the same risk, it is left to them to make their own judgments that may not be necessarily supported by any argument but expected to be true.
Reference
Dixit, A. K., &Pindyck, R.S. (1995). The options approach capitalinvestment. Real Options and Investment underUncertainty-classicalReadings and RecentContributions. MIT Press, Cambridge, 6.