Summary

This chapter explains briefly where companies get their money from and what it costs. In the first part we will consider debt, which is how people will choose to invest in a company if they do not want to take any significant risks. In the second part we will consider equity, which is invested by people who are prepared to take higher risks in return for the chance of greater rewards. In the third part we will consider how to allow for the cost of these two very different types of finance and how to link this in to our calculation of value. In this part we will also meet the idea of separating investment decisions from financing decisions and also the perhaps surprising presumption that if you have a good project, then money should always be available to finance it. The final part will contain the individual work assignments, answers to which are to be found in the Appendices at the end of the book.

The purpose of this building block is to provide the necessary background for individuals who are considering investment decisions inside companies. In particular it will give a basic understanding of where the cost of capital comes from and why we treat financing decisions separately from asset investment decisions. Although some insights may be gained regarding how to make one's personal investment decisions, this is not the main intention. Indeed there are good reasons why companies and individuals should adopt very different approaches to financial decision making.