A firm should continue to invest in capital budgeting projects to the point where the marginal cost of capital (MCC) equals the marginal return (internal rate of return, IRR) generated by the last project that is purchased.

Question

Quizplus · Accepted Answer

This is the concept of the optimal capital budget. The optimal capital budget is reached when the MCC equals the IRR of the last project that is purchased since this would ensure that the firm is maximizing its return on investment while minimizing its cost of capital. Continuing to invest beyond this point would result in lower returns and potentially negative net present value projects.

A Firm Should Continue to Invest in Capital Budgeting Projects