There is an unresolved, fundamental issue in capital budgeting. Companies that plan against a capital constraint are usually rejecting some projects which appear profitable. This discussion reasons that a capital constraint is inconsistent with knowing a company's Marginal Cost of Capital (MCoC). The incongruity arises because MCoC represents that additional funds are available at this rate, even if the full budget has been committed already. Thus, an extra project that would provide a return greater than MCoC should be funded, because it would contribute net value to stockholders. Companies accepting this reasoning can greatly simplify their project decisions. In particular, the widespread practice of ranking projects under an arbitrary capital budget ceiling is unnecessary.

The most fundamental and least assailable corporate decision policy is: Choose the alternative providing the greatest contribution to stockholder value. Although theoretically sub-optimal, there may be situations that preclude this decision policy in favor of project ranking. Also discussed are issues with valuing projects from a stockholder perspective and with implementing a value-driven decision policy.

You can access this article if you purchase or spend a download.