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How does working capital investment feature in project appraisal? What is sensitivity analysis in capital budgeting and how is it interpreted? Why is NPV considered superior to payback and ARR? How do NPV and IRR differ when ranking mutually exclusive projects? How is risk incorporated into capital budgeting decisions? How do taxes and depreciation (capital allowances) affect project cash flows? How do you appraise projects with unequal lives? What is a perpetuity and how is it valued? How do you estimate the incremental cash flows for a replacement decision? What is the modified internal rate of return (MIRR) and why use it?
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Budgeting & Forecasting › Capital Budgeting

What is the cost of capital and how is it used as the discount rate?

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Answer

The cost of capital is the return required by the providers of finance (debt and equity), often measured as the weighted average cost of capital (WACC). It's used as the discount rate/hurdle rate in NPV and the benchmark for IRR because a project must earn at least this return to satisfy investors and add value.
WACC = (E/V)xKe + (D/V)xKd(1-tax).
Real-world example The firm discounts project cash flows at its 9% WACC and rejects projects returning less.

Common follow-ups: What is WACC? | Why is it the minimum acceptable return?

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All 34 Capital Budgeting questions