A firm seeking to optimize its capital budget has calculated its marginal cost of capital and projected rates of return on several potential projects.... Accounting MCQs | Accounting MCQs

A firm seeking to optimize its capital budget has calculated its marginal cost of capital and projected rates of return on several potential projects. The optimal capital budget is determined by

Calculating the point at which marginal cost of capital meets the projected rate of return, assuming that the most profitable projects are accepted first.
Calculating the point at which average marginal cost meets average projected rate of return, assuming the largest projects are accepted first.
Accepting all potential projects with projected rates of return exceeding the lowest marginal cost of capital.
Accepting all potential projects with projected rates of return lower than the highest marginal cost of capital.Show Result

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Detailed Answer

Answer (A) is correct.
In economics, a basic principle is that a firm should increase output until marginal cost equals marginal revenue. Similarly, the optimal capital budget is determined by calculating the point at which marginal cost of capital (which increases as capital requirements increase) and marginal efficiency of investment (which decreases if the most profitable projects are accepted first) intersect.