The non-constant marginal cost of capital
faced by the company, however, requires a solution that is more complex than decision methods presented in textbooks, usually the case when real business situations are addressed.
Business persons can use WACC to measure the average cost of capital that they can then use as the marginal cost of capital
for expansion investments.
The marginal cost of capital
, k, should reflect only the market-related--that is, systematic--risk of the project (rather than the firm).
Basic economic theory predicts that firms invest in capital up to the point where the expected marginal efficiency of investment (MEI) is equal to the marginal cost of capital
Building on the idea that a weak legal environment increases the cost of external financing, the authors derive a model of investment in which changes in the marginal cost of capital
are identified by changes in leverage and by the interactions of leverage with the concentration of inside equity ownership.