Answer (D) is correct . The marginal cost of capital is the cost of the next dollar of capital. The marginal cost continually increases because the lower cost sources of funds are used first. The marginal cost represents a weighted average of both debt and equity capital.
Answer (A) is incorrect because If the cost of capital were the same as the rate of return on equity (which is usually higher than that of debt capital), there would be no incentive to invest.
Answer (B) is incorrect because The marginal cost of capital is affected by the degree of debt in the firm’s capital structure. Financial risk plays a role in the returns desired by investors.
Answer (C) is incorrect because The rate of return used for capital budgeting purposes should be at least as high as the marginal cost of capital.
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